Learn what shorting is and the pros and cons of shorting.

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It's Listener Question Friday

I've been watching the German bank, Deutsche Bank with some concern.

DB is trying to get a reduced fine from the DOJ from $14B to $5B for mortgage security improprieties during the last financial crisis.

If you haven't been following the news, DB may need a bailout but Chancellor Merkel has said she will not support one. That's because other banks in the EU may also need bailing out and if one was bailed out, they'd all have to be bailed out. Italy's banks are having big problems and so are other European banks.

The real problem with DB is it is unique in that id also has massive derivatives there, so if it goes down, the effect could be quite serious on the whole EU and the Euro. Remember derivatives are securities that do not include the underlying stock and can be bets on their directional change among other things.

DB has declined about 50% this year to roughly $12.

A listener asked, if I was watching Deutsche Bank and concerned it might fail, why not short it?

First, let me explain what happens when you "short" a stock.

You are borrowing shares that you sell at a high price and hope to buy them back at a lower price to "cover the short."

If a short goes against you, it's a potential unlimited loss!

There's also something known as a "short squeeze" which is quite common. Because investors know the shorts have to buy the stock to cover the short, they can buy shares and move the price up (if they are large enough, like a hedge fund is), panicking the shorts to pay any price to cover their short and protect themselves from large losses.

DB's stock price has been volatile. For example, in September it went from $15 to $11.50 to $13.99. Percentage wise those are 23% and 21% moves, so volatility is high.

They are making changes that could cause more volatility up or down in their stock price:

*They are laying off 1,000 workers. *The country of Qatar is rumored to be buying 25%. *They are also reportedly considering spinning off a subsidiary. *If there is any positive news, there goes the stock price up and away from the short trade.

So for all those reasons, I am not shorting DB. That's not to say some big hedge fund won't make a killing, but for the small investor there are other trades to be had and personally I prefer to be investing in what will go up, than trying to pick the precise time a stock will drop, which is what you need to do to be successful as a short.

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