Diana Clement: Bearish? Go get your shorts on

The average investor dreams of prices rising in whatever market he or she is in: Be it shares, property, commodities and so on. Yet sophisticated investors know how to make money in falling markets - using short selling and other techniques.

Until now, it has been difficult for private investors to short sell. New tax rules which come into effect from July 1 will make it much more accessible for private investors.

The concept of short selling is pretty simple. When you buy a share to sell once it rises in value, you're taking what's called "a long position". If you believe a share is going to fall you take a "short position".

"How it works," says Geoff Brown, products group manager at NZX, "is I decide I am going to sell Fletcher Building [shares] because I think the share price is going down. I am required to deliver them in three days' time. I don't own them so I need to borrow them."

Typically, large institutions lend their shares to short sellers via stockbrokers, so that they can do this. The institutions earn fees from the short sellers for lending their shares.

It's more than likely that only sophisticated investors are going to short sell in their own right. The risks are likely to put off all but those with nerves of steel. What's more, it's unlikely you'll be able to trade a few hundred bucks here and there, say brokers. However, unlike some other countries, there will be no limits on which companies you can short sell on the NZX, providing someone is willing to lend them.

Short-selling is nothing new. In Australia, it's permitted on certain securities only and, in the UK, there are no specific rules to cover it. It's also common in the US. There is nothing stopping Kiwi investors short-selling on overseas markets and a small numbers of investors do just that.

However, it has not been common here due to the fact that by lending securities, organisations crystallised a capital at the moment of lending - meaning that they had a tax liability on their holdings every time they lent them out if the value of the share had risen in the meantime.

Short selling is one of the main strategies hedge funds use to make money in falling markets. And, if you're invested in a variety of funds through a financial planner here, there's a good chance that there is some hedging within your portfolio.

The number one risk is that should the share price rise instead of fall, you will need to buy back at a higher price than you sold for. Timing can also be against you. Should the price not fall before the borrowed shares are recalled by the lending stockbroker, you'll still need to pay a fee for borrowing them, but won't make a profit on the trade.

Brown says that most stockbrokers will simply offer short selling as part of their stable of products along with warrants and margin investing. "It will be an additional service provided by broking firms who will arrange the lending part of this themselves."

Unfortunately for private investors, they may have to wait a while before short selling is available to them. Tim Preston, managing director of ASB Securities, said his company would not initially offer short selling to private investors because the industry was weighed down with all manner of administrative burdens.

Preston said he expected that the service, when it becomes available, would be suitable for sophisticated investors who understood the markets. "Initially, it will only be quite large investors. Someone is not going to lend 2000 Baycorp or Fletcher Building shares for example."

Frank Aldridge, chief executive of ABN Amro Craigs, said the service would be offered from day one to a "select bunch" of sophisticated customers, who understood the risks.

There's plenty of literature about short selling to help the beginner. That includes websites such as Investopedia.com, which explains it in plain English, to Morningstar.com, which has a short online course on the subject with a quiz at the end to make sure you've understood.

Among the myriad of books about short selling and bear markets is Taming the Bear by Australian Christopher Tate, which is particularly useful, says Vicky Powell, manager of the Good Returns Bookstore.