There is a good explanation why I don't talk about short-selling very much. Nearly every time I talk about a short-sell opportunity I receive lawsuit threats from the company I'm talking about and/or nasty emails from shareholders who own the stock. While we live in a free country, that freedom can come with a hefty price if you say something negative about a company. And, no matter how much I want to help you I've learned the hard way to keep my negative opinions to myself.

Yet, I know from my email that a number of you want to learn about short-selling as a strategy. The only way I can do that is to outline one of my own strategies, especially a strategy I've talked about a little in the past that continues to reap pretty decent returns in this market.

First, you have to identify a sector target. In simple terms, I frequently look for hot sectors ripe for an extended pullback. I do this based on my constant review of the sectors under heavy accumulation, how sectors perform in relation to their typical p/e ratios, severely overbought technicals, as well as keeping on top of the headlines. Once a sector starts receiving a ton of press, investor interest, and market speculation, I also become interested in taking the other side of the trade especially if the trend looks to be closer to the end rather than the beginning of the up cycle.

Second, you have to focus on position timing. It is true, sector trends tend to last much longer than logically possible. The market tends to overshoot all major moves and if you don't time your position correctly, you're going to be in a world of hurt. Take for example the homebuilding sector. Every time over the past few years that this sector looked ready for the proverbial toilet bowl flush, these stocks have come back with a vengeance. That's why even though some skilled investors will eventually make a retirement from shorting Toll Brothers' (TOL), on balance more people will lose money being short than long that stock. Sad, but true.

Third, you have to set your sights on the sector's worst performers. There have been many times I've been right about a reversal in a sector and a specific stock, but just painfully wrong on the timing. That's why I don't spend time and money shorting the top dogs in a winning sector. Instead, I search for and find companies that can't cut the mustard when times cannot be better. If you narrow your focus to shorting only these stocks, you'll find many more opportunities than you can take advantage of. Sure, there are times I get trapped in classic turnaround situations, but if you do your research you'll be able to eliminate the vast majority of those rare situations. Losers tend to keep losing, just like winners usually keep winning.

Using homebuilding again as an example, that's why I went short Dominion Homes (DHOM) earlier this year (see this post). Because I found a big loser in a hot market, I didn't have to be as concerned with timing the reversal, especially when there were few signs of a major turnaround. As you can see from the performance of Toll Brothers (TOL) versus Dominion Homes (DHOM) below, that turned out to be a good decision.

In sum, short-selling is a viable and effective strategy particularly for patient and well-researched investors. Although I don't talk about it much at the website for the reasons previously identified, you should know that I incorporate short-selling within my retirement accounts and I think most would be wise to do so once they've developed the skills to spot standout losers in the market's top sectors with a great deal of consistency.