Short Selling A Stock: How It Works
The stock market is a great place to make a lot of money on the money you already have. By making an investment and allowing it to grow you can get much more than what you had to begin with.
That being said, most people think of the market as only working one way, and that is an incorrect perception. The fact is it is possible to make money when the prices of stocks increase and when they decrease by short selling.
When it appears as though the prices of stocks are over-priced an investor has two options. He may wait for the prices to come back down and purchase them at a more reasonable price. Alternatively, one may decide to “short” a stock. This is essentially a bet that the price of the stock will decrease. If it turns out this way, the investor who has shorted the stock makes money.
How To Sell Short
The way this process works seems complicated at first but is actually straightforward once it is understood. In order to short a stock one must first borrow shares from your broker, most stocks are on a good to borrow list so you just have to enter a short order, in that stock and sell them in the open market.
This all happens electronically and requires no in person negotiations at all. If there are shares available to short one may do so. You borrow the shares and sell them at the current price in the hopes that the price will fall. It is important to note that you can only sell short in a margin account because you are borrowing the shares and that is only allowed in margin accounts.
If the price of the shares does fall and you are prepared to lock in a profit, then you may “cover” the short. That is to say that you purchase the shares at the now lower price in order to replace the shares that were borrowed earlier. The difference between the two prices is the profit that you lock in. Of course, on the other side of this is the possibility that you could lose money as well.
Losing money on a shorted stock would mean that the price of the shares continued to rise after you shorted it. You borrowed shares and sold them at one price, but now they have only continued to rise in value.
Therefore, you would have to buy them at the higher price in order to recoup the shares you already borrowed. You can allow this to play out for a while, but you must have enough funds in your account to cover the cost of the now more expensive shares.
Short Selling Is Risky But Can Pay Off
Shorting a stock can be risky as there is limitless upside to a stock. When purchasing a stock you know that the absolute floor on the price is zero, but that is not the same when you short a stock. There is no ceiling to the price, and you could be on the hook for a lot of money potentially if the price of the stock you have selected increases in value dramatically.
Shorting is a strategy used by those who believe that the prices in the market are too high and be a very lucrative strategy short selling stocks. This is because stocks have a tendency to naturally grind up but when shares are being sold off it can happen very quickly and give you profits just as fast. Learn how to short and you will be a more versatile trader.