(MONEY Magazine) – By almost any measure, 1997 has been yet another blockbuster year for stock investors. But now, with many experts, including MONEY's investment strategist Michael Sivy, predicting tougher times ahead, you may feel very much like a nervous matador staring down an angry bull on its last legs. Will you be able to pirouette out of its way when it makes its final charge? Is there any way for you to lock in your gains now and avoid serious injury to your portfolio later, when the inevitable correction finally comes?

One answer may be to go short--that is, borrow shares from your broker, sell them and then buy them back for less money after the price of the stock has fallen. Your profit is the difference between what you received when you sold the borrowed shares and what you paid to replace them, minus brokerage commissions. Though short-selling can be an extremely high-risk strategy for reasons we'll explain in a minute, used properly and limited to no more than 5% to 10% of the value of your portfolio, it can also be an effective way to hedge against loss in a sliding market.

Before we tell you how (see the box on page B12 for the names of some potential candidates for shorting), we need to spell out the risks we hinted at. First tip: This is not a strategy to be pursued by anyone who is afraid of getting gored. Unlike going long and buying stock, you can lose many times the value of your initial investment when you go short. "Your losses are potentially unlimited," says Harry Strunk, a Palm Beach, Fla. broker who keeps data on the performance of short-sellers.

Here's why the risk is high. Suppose you buy 200 shares of a $50 stock. What's the worst that can happen to you? The company files for bankruptcy, and you lose your entire $10,000. Yes, that's very painful. Now suppose that you short 200 shares of a $50 stock. But instead of falling, the stock triples. The $50 stock becomes a $150 stock. To replace the 200 borrowed shares and close out your position, you've got to pay $30,000--so you're actually out $20,000 on a $10,000 investment. That's not painful--that's excruciating. It's also the reason why Gerald Kuschuk, a senior vice president with Prudential Securities, calls shorting "the most hazardous strategy out there for the individual investor."

Before you embark on your first short sale, most experts recommend that you have securities or cash in your account worth 100% of the value of the shares you are shorting. Brokerage rules call for 50% when you make the trade and at least 25% to 30% in your account as collateral after that. Put up just 50%, however, and you could be forced to cough up more cash or securities as collateral if the stock rises more than 10%. Fail to come up with the green, and the firm can close your position without telling you, saddling you with hefty losses.

Still interested? Then here's the quick course. You can sell short only after the stock's price has moved up by at least 1/16. This so-called "uptick" rule is designed to keep short-sellers from ganging up on a company and forcing its price down. The proceeds will be deposited with your broker within three days, but you will not have access to this money or receive any interest on it until you've closed out your trade. Any stock dividends owed to the customer who lent your broker the shares will automatically be paid in cash from your account. You can hold your short position as long as you want, putting up additional collateral when the price moves against you. But your profits will always be taxed as a short-term capital gain, meaning you'll pay ordinary income taxes on them and not the lower 20% for long-term capital gains. You can minimize your risk by observing the following rules:

START SMALL. Begin by shorting a hundred shares to see how the process works. And keep your short holdings small in relation to your total portfolio. Says Paul McEntire, chairman of Skye Investment Advisors, a Los Gatos, Calif. money manager who specializes in short-selling: "If you allocate 10% or 15% of your portfolio to a single short position and the stock quadruples, you can wipe out years of good investing."

DIVERSIFY AMONG THREE TO 10 STOCKS. When a shorted stock moves against you, it becomes a bigger part of your portfolio and the risk gets greater. Use at least a handful of shorts to prevent one from overwhelming your portfolio.

SET A LIMIT TO YOUR LOSSES. Most experts suggest that you close out a short position if a stock rises roughly 25% above where you sold it. Or, buy the stock back if its price goes above the high point it has hit during, say, the preceding 52 weeks. Once the stock reaches your limit, close out your trade. Otherwise, you can take a pounding from so-called momentum investors, who jump into stocks on the rise, pushing their prices (and your short-selling losses) even higher. You can short the stock again once it ceases its upward spiral.

DO YOUR OWN HOMEWORK. You can't expect your broker to help you pick a short candidate. Says Sal Campo, a managing director at Smith Barney: "A broker might call you up and say that Dell Computer is a good buy, but he's definitely not going to call and say: 'Dell's overvalued. Why don't you short it?'" As you've long suspected, analysts at big brokerage firms are loath to write negative reports on the companies they cover for fear that the brokerage will lose the outfit's investment banking business. And firms usually prohibit their brokers from initiating discussions on companies that aren't covered by their analysts.

That means you'll have to come up with your own ideas. One strategy is to piggyback on the work of more sophisticated investors by putting money in the most heavily shorted stocks. These are listed in monthly tables that appear in the Wall Street Journal and other newspapers, usually under the heading "Short Interest Highlights." But be sure to ask your broker whether the stock is hard to borrow; if he says yes, stay away. Another option is to subscribe to a stock rating service such as Value Line Investment Survey ($570 a year; 800-833-0046), which ranks stocks in terms of whether you should buy them from 1 (best) to 5 (worst). Look at the bottom end of those lists instead of the top end.

Of course, short-selling isn't your only choice if you're nervously eyeing the bull market. But some investors want to flash that red cape. If you're one of them and can handle the risks, ole!