The Japanese stock market has been volatile in the 21st century. In mid-2007, the benchmark Nikkei 225 index reached 18,240 points. By early 2009 it had fallen to around 7,000. A year later it topped 11,000. After falling again, it rose to over 16,300 at the end of 2013. To make money in a falling market, you can short sell the market or market segments. Timing the moves properly can lead to considerable trading gains while getting them wrong gets expensive quickly.
An exchange traded fund (ETF) is a diversified pool of stocks that functions like a mutual fund but is traded like a stock. There are more than a dozen ETFs that offer a cross-section of the Japanese stock market. You can buy shares in them through a U.S. broker, just as with any other equity. Japanese ETFs range from index funds covering the entire Japanese stock market to more specialized funds that concentrate on value, growth or equity size. Any of these funds can be acquired with a short sale.
Shorting an ETF
Shorting an ETF is similar to the procedure for buying one. If you are using an online brokerage, you first specify the ticker symbol of the ETF you're shorting. You will next be asked the action you wish to take: buy, sell or sell short. Specify "sell short," then complete your order by specifying the number of shares you are selling short along with some purchase details.
Leveraged Japan funds, which their sponsor calls "ultra funds," multiply your investment by a factor of two. If the equities underlying your fund fall 1 percent, your fund rises 2 percent. Similarly, if the equities underlying your fund rise 1 percent, your fund declines 2 percent. Many market professionals advise retail investors not to leverage their investments as doing so increases the volatility of your investments and the risk of investing.
Shorting an equity is not necessarily wrong, but you should understand the risks involved. If you buy 100 shares of a given stock for $10 each and the company fails completely, you can only lose your original investment of $1,000. If you short an equity, in theory your losses can be infinite. As the price keeps going up, you continue losing money and your loss is potentially unlimited. This kind of gain or loss does not happen often in the stock market, but the risk is there. The only way to stop losses from short sales in a rising market is by buying the same equity. When you sell short you borrow equities and promise to pay for them at a later date at whatever their price may be. When you buy the equities you can return what you borrowed.
Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.