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A taxing problem: How traders are playing year end selling

As the year comes to a close and investors square up their portfolios, many may look to sell out of losing positions for tax purposes.

That could mean further weakness for beaten-down assets in the short-term, but may also present attractive opportunities for those looking to snatch up underperforming assets at a discount.

Buying assets that others have sold for tax purposes "most certainly is something that can be very useful at this time of year," said John Stoltzfus, chief market strategist at Oppenheimer. "I think it's a very good opportunity if you have a picture of where you think we're going" in the year ahead.

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The idea behind tax-related selling is that individuals who have experienced capital gains in a calendar year can offset the taxes paid on those gains by showing losses on other investments. For that reason, in a year where many thing have performed well, badly performing assets can add to selling pressure.

Tax selling was certainly blamed for gold's plunge at the end of last year.The S&P 500 was up 27 percent in the year to December, while gold was down 25 percent during that time. Those who wanted to offset taxes on sales of winning stocks were assumed to sell gold for a loss—which would explain why gold continued to drop in December, and hit the dead lows of the year on Dec. 31st.

This time around, the obvious candidate for tax selling is crude oil, which has fallen almost 50 percent from its highs on the year.

Just as gold simply kept dropping at the end of 2013, "I would expect that you would see the same thing for the crude oil market. There [are] a lot of traders, a lot of positions, that are long right now, and they're going to want to liquidate before the end of the year," said NYMEX energy trader Anthony Grisanti of GRZ Energy.

Of course, it hasn't been a great year for many commodities. Gold, too, is off of its highs, which makes Bill Baruch of iiTrader think it could succumb to tax-related selling in the sessions ahead. Still, Baruch says the better trade isn't going short for the short-term, but looking for the buying opportunities that tax-pressured selling could create.

"What you want to take away from this is not only a bearish bias in underperforming commodities towards the end of the year, but also the late holiday gift it leaves," he told CNBC via email.

Investors can easily snap up battered commodities at the start of 2015, Baruch said. Additionally, "those commodities can also see a further boost as fund managers look to reallocate into underperforming assets, creating what can potentially be a bullish bias to start the year."

Getting 'emotional' amid the selling

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Spencer Platt | Getty Images

The same trick could work for individual equities and ETFs, particularly those exposed to oil. Jeff Saut of Raymond James advocates taking advantage of the oil weakness by "buying midstream MLPs in tax-loss selling season."

Oppenheimer's Stoltzfus, who has a 2015 S&P 500 target of 2,311, says that "we'd be shopping" amid the selling, particularly in "spaces where you'd see opportunities created by current results that leave investors disappointed."

When it comes buying to energy stocks, "you have to be a bit of a contrarian," he said. "You won't look great at the cocktail party, but you might look great a year from now."

Specifically, Stoltzfus says that downstream oil names (in other words, companies that process and sell oil and gas products) like Chevron and Valero look attractive.

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On the other hand, strategies like buying assets that some are selling for tax purposes might work better in more predictable times, or for more stable assets than crude has proven to be.

"There's so much [turmoil] going on in the commodity markets here that tax loss selling is the least of their problems," said Andrew Hecht, a former commodities trader and the author of How to Make Money with Commodities.

And as for those tempted to sell in order to harvest losses? George Clough, a financial planner with People's United Bank Wealth Management, says that it's important for investors to "look at their overall situation, rather than letting the tax-tail wag the tax-dog."

Clough added: "Unless something really objective is saying this is the time to get out of that losing investment, maybe tax reasons aren't strong enough to warrant a sale. And frankly, studies show that emotionally pulling money in and out of markets doesn't really yield the best results for our clients," he said.

Clough worries that part of the rationale behind late-year sales is often an emotional desire to shed losing investments before the new year begins. This would help explain the rush of tax-related selling as December draws to a close, even though tax-loss harvesting can happen at any point in the calendar year.

If an individual really have a good reason to get out of an investment, "Why didn't they think about this earlier?" he asked rhetorically.

—By CNBC's Alex Rosenberg.

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