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How to Short a StockBy Tom Dyson, editor, S&A Penny TrendsMonday, July 20, 2009 A trader who won't short a stock is like a tennis player who can't hit a backhand...
Despite the S&P's massive rally, we're still in a bear market... and there's a good chance stocks will offer more downside than upside over the next few years. At the very least, we'll see plenty of volatility and many great shorting opportunities. To maximize your skill as a trader, you've got to know how to short a stock.
When you short a stock, you make money if the stock's price falls. Shorting is the exact opposite of buying. Let's say you short shares of Company X. If its stock falls from $10 to $9, you'll make $1 in profit per share. If you had bought shares of this stock, you'd have lost $1 per share.
In Penny Trends, we use this technique to make bets on weak stocks with prices in downtrends.
Here's how the mechanics work: You tell your broker you want to short a stock. Your broker borrows the stock and lets you sell it, even though you don't own it. When you close out the trade, you buy the stock back and then give your broker back the stock you borrowed.
In practice, you don't have to worry about the borrowing and lending of the stock. Your broker's software and computer systems take care of all that behind the scenes.
You make a profit if your buy-back price is below your opening sell price. You make a loss if you buy the stock back for more than you got selling it.
When you short a stock, in theory, your losses are unlimited. The stock could triple or quadruple in price, and you could lose a fortune. (In Penny Trends, we always use stop losses, so we'll never risk an unlimited loss.)
To protect itself against these potential losses, your brokerage will require you to post cash in your account. My broker requires a minimum balance of $5,000 in the account before it'll let me short a stock.
After you make an initial deposit, you'll have to enable your account for margin trading. Margin trading is a service your broker offers. It's a way for your broker to lend you money. (Brokers love lending their clients money. They earn interest and their clients trade more stocks, generating more commissions.)
To enable margin trading, open your account profile on your broker's website and look up account features. You'll find an option to enroll in margin trading. You'll need to submit an online form and then wait for your broker's approval. It's quick and shouldn't take more than a few minutes. Your broker wants to know you understand the stock market and you aren't totally inexperienced. If you have any problems, give your broker a call. He'll set you up in a flash.
Think of margin as overdraft protection in your bank account. But please remember, if you stick to a stop loss, you'll never have to worry about "going overdrawn" and using your broker's margin.
Right now, when you look up a stock on your broker's website, it'll give you the option to "buy" it, "sell" it, or "sell all shares." Once you have the margin trading capability set up, a new trading option will appear: "sell short." Simply enter the number of shares you want to short, and click "sell short."
You should sell short the same number of shares you would buy if you were betting on a rise in the stock. You can't short some smaller stocks... and sometimes a stock might be so heavily shorted or illiquid, your broker won't have any stock for you to borrow in its inventory. If this happens, your broker's software won't let you place the trade. You should call up your broker and have him look for the stock at other brokerage houses. He won't charge you for this service.
Shorting is easy. Take a few moments to set things up and you're ready to place your first short trade. If you have any questions, you should call your broker or search the Internet. You'll find many free resources that explain in detail how shorting works.
Do your research soon because the market's had a 40% rise in the last four months... and may be due for a significant correction later this year. Be ready to profit.
Good trading,
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