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Short Selling basics.

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Blinton   Friday, 05/28/10 06:40:42 PM
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Short Selling basics.

A Quick Explanation From Investopidia

When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later, you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.

My Overly-Simplified Explanation

Five steps for short selling:

1) Setup margin on your trading account so you're able to borrow from your discount-broker.
2) Find a stock you think is going to fall. We're going to short in order to make money off of the downward action.
3) As you initiate a transaction to short the stock, your broker will borrow shares from someone holding the stock and lend them to you. You've basically wrote an IOU. At this point you've virtually "sold" shares without ever owning any, crazy right?
4) After the stock goes down enough and you're happy with your profits, it's time to end the trade. So you buy some actual shares - otherwise known as a cover - to make up for the shares that you borrowed earlier.
5) You give the actual shares to the person that you borrowed shares from, and you get to keep the difference as profit. Now you're rich rich rich.

As an example

Let's say you borrow 100 shares priced at $5 (i.e. start a short position). Then after the stock falls to $4 you actually buy 100 shares (i.e. cover you're short position). Next you give the $4 shares that you just bought to the guy you borrowed shares from so you're both even steven. Now you've just make a $1 profit off of the shares dropping a $1, and the sucker that you borrowed the shares from was none the wiser. Makes sense now?

The Short Selling University at Investopedia

This investopedia tutorial is very helpful if you want to learn more about short selling.

http://www.investopedia.com/university/shortselling/

Table of Contents
1) Short Selling: Introduction
2) Short Selling: What Is Short Selling?
3) Short Selling: Why Short?
4) Short Selling: The Transaction
5) Short Selling: The Risks
6) Short Selling: Ethics And The Role Of Short Selling
7) Short Selling: Conclusion

Additional Resources

http://en.wikipedia.org/wiki/Short_(finance)

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