Short Selling is the process of selling a stock first, without actually owning the stock in the first place, at least from an individual trader or investors point of view.

Individual investors and traders, Hedge Funds, and large Institutional Investment firms are all involved with shorting stocks on a regular basis.

When selling a stock short, your intention is to sell the stock first and buy the stock at a later time, called buying back or covering your position or buy to close, at a lower price than you initially sold the stock for. This is in contrast to a normal investor transaction when you buy a stock first, and then sell it at a later time.

Why Would You Want To Do This?

Take for example a company called XYZ that is trading at $50.00 per share. The company has shown consistent profits and growth over the last 5-10 years. The company knows exactly what type of assets they own, or on their balance sheets, and they know the value of these assets can be calculated in different ways to produce different amounts of profits or losses when they report their earnings to the public.

In order to keep the company stock price rising, each quarter when they report their earnings they choose to calculate the value of these assets using a method that shows the highest value.

Over the next few quarters, the value of these assets are drastically reduced because of a slowing economy and other things beyond their control.

One day a news report comes out that the management of the company has not been reporting the value of the company assets, we’ll call these Mortgage Backed Securities in this case, accurately. After these news reports come out, if you own the stock you would probably sell your shares.

If you did not own the stock, would you want to buy this particular stock? Of course not. This is a situation where you would want to start Short Selling, or short the stock.

So the times you would want to be Short Selling would be when you think a stock price is going down in the future. This could be for reasons as I said in my example above, or many other reasons that show negative pressures towards a company such as:

Slowing Sales Company Scandal Poor Management A Misleading Management Macroeconomic Conditions Microeconomic Conditions Possible bankruptcy

How Do I Short Stocks?

When you want to start shorting stocks, you must first have a Margin account setup. The reason is that when you sell the stock first, you are selling a stock that you do not own and promising that you will produce the stock at a later time.

Having a Margin account is like having a credit line from the bank and the amount is determined by your account balance multiplied according to specific regulations.

In order to be able to short a stock, the stock must also be available to borrow ahead of time by your broker, so that you can sell it in advance.

The steps to short stocks are the opposite of when you buy stocks. First you place an order to sell shares, and once your trade is executed, you then have to buy the shares back, or cover at a later time or date.

How Do I Make Profits Shorting Stocks?

In order to make a profit when short selling, you must buy back your shares at a lower price than what you initially sold them for.

Example:

1. You place an order to sell short 100 shares of XYZ stock at $50 per share.
2. XYZ drops down to $40 per share.
3. You place an order to Buy To Cover 100 shares at $40.00
4. This results in a profit of $10 per share or 25% before commissions.

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