Tax Loss Selling

You might have noticed towards the end of year a lot of traders throwing around the term tax loss selling, but did you know what it meant?

Before we can sum up what tax loss selling means lets first clear up some facts about taxes relating to stock trading particularly.

Whether you close your stock position at a gain or loss it has an effect on your yearly tax returns. Obviously the quicker you make money, the higher taxes are. This is commonly referred to as short-term capital gains tax.

There are a couple varying terms, but on average a gain is considered short-term if it was made in less than 6 months to a year.

Just like businesses can write-off expenses or losses, so can individual traders. Using this method many traders use their losses to offset taxes for any gains. While the country files there tax returns in August, capital gains are calculated through the previous December 31, which is why you may see unnormal or unwarranted selling around November and December.

Sell your losers and take your losses now – that is tax-loss selling in a nutshell.

A good way to capitalize on tax loss selling is by shorting stocks; however, it can be risky. Although you shouldn’t put too much emphasis on tax loss selling when considering to take part of a stock, there are a couple factors you can look for when searching for companies that could fall victim to tax-loss selling.

1. Look for stocks that traded well above their current price for much of the year. Check out the daily volume and see if the high-price period corresponds with high volume too. That means a lot of folks bought the stock at much higher prices than now. They may sell it for the tax loss before December 31.

2. Look for companies with large floats, i.e. a lot of shares available for the public to trade. This is a good rule for short-selling in general. Stocks with small floats (less than 5 million shares) can be hard to borrow and short to begin with. If they are already heavily shorted, the chances are greater you could get caught in a “squeeze” as the price runs up and shorts are forced to cover at desperation prices.

Using the above factors along with other criteria you would normally look for when finding shorting candidates, hopefully next year you can take advantage of tax loss selling rather than just taking part in it.

Learn more tax tricks and tips for stock traders.