How to Make Money Selling Stock Short

When the price of a stock falls, some people still make money by short selling the stock. But just how do you make money selling stock short? The basic idea is that you agree to sell the stock at a later date for the current price. If the price falls, the buyer will still have to pay the current price and your keep is the difference. The actual process is more complicated, but the steps below explain how to do it.

Things You'll Need

• Brokerage account with margin privileges

Instructions

1. Learn how a short sale works. When you short sell a stock, you don’t actually own the stock at the time. Instead, you borrow the stock from your broker to secure the transaction. At a future date, you complete the transaction by buying the stock on the market and delivering it to the buyer, who must then pay you the price of the stock had when the contract was made. If the stock has declined in price, you make a profit.

2. Arrange with your broker to have margin privileges. Because you borrow the stock from your broker, a short sale is a transaction “on margin.” This means you must meet certain conditions. You pay interest on the value of the borrowed stock and must keep enough money in your brokerage account to cover the margin requirement. The money you put up for the stock you borrow will be put in escrow. Any money and stock in your account is collateral for the short sale.

3. Know the limitations of selling stock short. Brokers can only loan stock they own, so you may not be able to short sell a particular stock. Normally, a broker will not do a short sale if the stock is falling in price, so you must find stocks that are likely to decline in price but haven’t started doing so. Your broker still owns the stock and will collect any dividends. Finally, since this is not an investment in a security you expect to rise in value, you won’t be able to take capital gains deduction on any profits.

4. Look for stocks that are likely to fall in price. Speculators who are experienced in short selling search for companies that have bad fundamentals and so are likely to be overvalued. Another strategy is to watch for stocks that are sensitive to changes in the market or to external conditions such as the price of a particular commodity. If you have reason to think one of these external factors will adversely affect a company, you have a candidate for a short sale.

5. Monitor the stock and the market closely. Selling stock short is a short-term transaction, and you usually complete the transaction within a few weeks, or at most, a few months. Keep a close eye on the stock and how it is performing, because you may need to make a decision to sell it on short notice.

6. Complete the transaction. Once you’ve actually completed the sale, you will return the borrowed stock to your broker. Don’t be discouraged by the complexity of this transaction. For the most part, brokers will handle the details much as they do when you buy a stock or other security in the usual fashion.

Tips & Warnings

• While you can make money selling stock short, you do need to have a solid grasp of stock trading and how stock transactions work. It’s a good idea to start by gaining experience in more conventional transactions before you try selling stock short.

Resources

• Basics of Selling Stock Short