(By Dave Goodboy) It can easily be said that change is the only constant in the stock market
, and nowhere is this fact more evident than in the technology sector. The financial world's graveyard is littered with tech companies that failed to innovate. The ability to identify these companies so as to avoid them, cull them from your portfolio or even short-sell them is the mark of a successful tech investor.
One of my favorite things about being a self-directed investor is the ability to change with the market. Unlike being stuck in a passive, long-only mutual fund reliant on a one-trick pony manager, a self-directed investor has the ability to profit regardless of which way the market goes. The capability to profit as a stock declines provides a definite edge in the uncertain stock market.
One way to profit from a stock's decline is through short-selling. Although some people may disagree, there is nothing morally wrong or unethical about short selling. In fact, it can be argued that short sellers play a vital role in the integrity and balance of the financial markets.
To sell a stock short, the investor borrows shares of a company expected to decline from his or her broker. If the shares drop from the price at which they were borrowed, the investor sells them back to the broker, keeping the difference between the selling price and the borrowed price as profit. Selling back to the broker is called "covering."
Obviously, if the stock price does not drop before the trade is covered, then you will lose money on the commissions and the price difference as the stock rises. Since stocks can theoretically keep rising to infinity, your losses can theoretically be unlimited when shorting. In contrast, when taking a long position in a stock, shares can only go to zero, capping your losses to the price paid for the stock. In reality, though, stocks do not go up forever and short trading losses can be judicially managed via stops and position sizing.
With this in mind, these three high-tech stocks are currently ripe for short-selling:
1. Research In Motion (Nasdaq: RIMM)
RIMM has been a short-sellers dream since January 2011, when the stock's downtrend started in earnest. The company became a big hit with investors with the rapid adoption of its BlackBerry smartphone, which displaced Palm as the smartphone of choice for corporate users.
But competition from Apple's (Nasdaq: AAPL) iPhone and the Google (Nasdaq: GOOG) Android operating system quickly surpassed the BlackBerry in terms of ease of use and features. Although they keep trying, Research In Motion seems to be unable to launch a successful competing product.
Although this company trades at about 5 times earnings, it's a dinosaur, and every bounce should be shorted. It wouldn't surprise me to see this stock under $4 per share within the year.
2. Seagate Technology (Nasdaq: STX)
This hard drive maker's short story is not as clear cut as RIMM's. The disastrous floods in Thailand last year hurt the company's largest competitor, Western Digital (Nasdaq: WDC), providing Seagate the opportunity to ramp up the price of its hard drives. This, in turn, pushed up the stock price.
But this is a short-lived advantage as Western Digital will soon be fully functioning, forcing Seagate to bring prices back down. Despite its performance this year, I like this as a short between $28 and $32 per share with stops at $35. I expect to see this stock below $18 within the year.
3. Brocade Communications Systems (Nasdaq: BRCD)
Brocade makes storage area network switches. Basically, these switches enable companies with multiple computer servers to move traffic between them. In addition, the company is involved in the Ethernet business used in home and business networks. Both of these businesses have been very good to Brocade, but the party may be ending.
Morningstar is projecting that the network switch business should only grow 3% annually. And in the Ethernet business, BRCD faces stiff competition from Cisco (Nasdaq: CSCO). Morningstar's analysts say that although Brocade is heavily pushing the Ethernet business, it simply cannot compete with industry leader Cisco.
I like Brocade as a short right now and wouldn't be surprised to see shares below $4 within the year.
Risks to Consider: Shorting stocks is risky because of the inherent upward drift of the stock market. It takes pinpoint timing and analysis to correctly pick companies ready to fall; however, the rewards can be substantial. Things can change quickly in the financial world, particularly in tech stocks, so stay nimble should you decide to short these names. Just like when buying shares, be certain to always use stops and position size correctly.
Action to Take --> I recommend shorting all three of these tech stocks. Research In Motion has proven itself to be an ideal candidate for shorting on any bounce. Seagate appears to be a solid short setup right now with stops at $35. Brocade is more speculative, but I think it makes sense as a short candidate at current levels.
-- Dave Goodboy
Dave Goodboy does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of GOOG, CSCO in one or more if its "real money" portfolios.
This article originally appeared on StreetAuthority
Author: Dave Goodboy