This is the time when investors sell their losers, take their losses, and use them to reduce their taxes. The sharp drop in the stock market could cause one of the biggest waves of tax-loss selling in several years.

Investors can carry forward tax losses indefinitely and use them to offset future gains. Let's take a specific example and assume that you have short-term loss of $8,000 and a long-term gain of $3,000. You would have a remaining loss of $5,000. This loss can be carried forward indefinitely. However, you can deduct only $3,000 a year against ordinary income. You must designate your loss as either short or long term.There is another rule which says that you can buy stocks to replace the ones you've sold, but you cannot buy back the same stock.

This year, for some people, the losses are so large that it will take them the rest of their lives to use them up. Many investors wait until the last two or three days because they have an aversion to "biting the bullet," so to speak. There is a different psychology in selling, especially selling at a loss. Often your emotions and your ego come into play; I know some people who understand the tax laws and still refuse to take advantage of them. I often hear them say: "I'm going to keep this stock because I know it will come back next year." Others agonize and torture themselves, going back and forth weighing the advantages of selling against their refusal to admit to mistakes. Still others rely on their brokers or financial advisors and blame them for their losses.

With stock markets continuing to free fall, investors should explore the option of tax-loss selling now. While harvesting losses on stocks to offset capital gains is customarily done in October and November, smart investors will realize that there is no reason not to do the same now. Over the last week, I have been working with my clients to sell their losers and realize the loss. Either they will be able to use the losses to offset gains which hopefully will come later on this year, or the losses can be rolled over for next year as well.

Those of you in former high fliers such as Baidu.com (NASDAQ: BIDU), First Solar (NASDAQ: FSLR) and Apple (NASDAQ: AAPL) who are lamenting your steep losses of the last month have no fear. By taking losses on those stocks now, you may actually profit from your losers.

Aaron Katsman is the lead Portfolio Manager and Managing Director of America Israel Investment Associates, LLC. and Senior Editor of IsraelNewsletter.com. DISCLOSURE: Writer has no positions in any stock mentioned as of 1/23/08