Sell Vs. Sell Short
Selling a stock and selling a stock short are two very different actions. Investors sell stocks they own for many reasons, including fear, taking profit or just to raise cash for other needs. A person who sells a stock short on the other hand, sells stock he doesn't actually own for the purpose of profiting from a potential future price decline. Short sellers sell borrowed stock shares and they are obligated to return those shares to their owner at a future date.
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Shorting Basics
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Short selling offers investors a way to profit from stock price declines. A short seller borrows shares from her broker and sells them on the open market. If the price declines, she can buy back those shares at a lower price. The difference between the price she sold them for and the price she was able to buy them back for is her profit.
Sell Short or Just Sell?
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Investors sometimes sell stock they own because they believe prices will decline in the future. If you just sell a stock you own, you collect cash for the sale and are protected should the price fall after you sell. If you wish to also profit from declining prices, you can actually sell more shares than you previously owned. The additional shares you sell would be credited as a short sale with your broker. If you are subsequently able to return those shares to your broker by buying them back at lower prices, you can also profit from the price decline you predicted.
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Short Selling Risks
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When you buy a stock, your risk is limited to the price you paid for your stock. The price of a stock can never decline below zero. If you sell short, however, your risk is theoretically unlimited. There is no limit to how high a stock price can rise. Because short sellers are obligated to return borrowed shares, if the price continues to rise after they sell short, they will be obligated to buy back the same number of shares they sold, even if they have to pay more for them than they were able to sell them at.
Short Selling Alternatives
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There are alternatives available for investors who wish to profit from stock price declines, but do not wish to accept unlimited risk involved in selling short. An Exchange-Traded Fund is a stock fund designed to rise and fall with a market index, such as the S&P 500. There are also inverse ETFs designed to rise when the index they are tied to declines. For example, the inverse ETF QID rises when the NASDAQ index declines. If you buy QID, you are essentially short the NASDAQ. However, like a stock, your risk is limited to the price you paid for the fund.
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