Short Selling in Stocks
Stock investors profit when stock prices rise and they lose money when stock prices fall. Selling stocks short, offers a way for investors to profit from falling stock prices. Short selling stock involves selling stock you do not own with the intent of buying back the same number of shares, hopefully at lower prices, at a future date. If you are able to buy back the shares for less money than you sold them for, you get to keep the difference as profit. However, if the prices rise, you will have to pay a higher price and take a loss.
-
Short Sale Basics
-
Assume, for example, that you believe Microsoft, which is currently trading for $100 a share is likely to fall in the near future. To sell Microsoft short, you borrow shares from your broker and sell them to someone else for $100 a share. If Microsoft subsequently falls to $90, you can repurchase the same number of shares you sold, returning them to your broker. The $10 difference between your selling price and the price you paid to buy the shares back represents the profit you made on the trade.
Margin Requirements
-
Trading margin is a loan you take from your broker in order to buy more stock than you could otherwise afford. Because shorting stock involves a loan from your broker, short selling requires a margin-approved brokerage account. When you borrow shares from your broker, your broker will charge you an interest fee until you return the shares.
Benefits of Short Selling
-
Some people believe it is immoral to make a bet against company stock by selling it short. However, short selling provides an important stability factor in the markets. When stock prices fall, investors can panic, driving prices lower and lower. However, if you are short a stock, falling prices mean your profit is increasing. At some point you will want to take your profit by buying back the shares you sold. As short sellers take profit, they create buying demand for stocks, stemming the tide of selling.
Alternatives
-
Shorting stock can expose you to theoretical infinite risk. There is no limit to how high a stock can rise, so you can potentially lose much more than your original investment. Inverse Exchange-Traded Funds offer a safer alternative. An inverse ETF is designed to rise when a stock index it is tied to falls. For example, QID is an inverse fund that rises when the NASDAQ index falls. Owning QID is essentially the same as being short NASDAQ and you do not need a margin account to buy it.
-
