The best stocks traders are those who have perfected the art generating profits on stock trades irrespective of whether stocks are rising, channeling, or falling. The fact that you are reading Daily Trading Profits shows that you are interested in learning how to make profitable trades irrespective of the market direction. I will show you exactly how to make profits when other traders and investors are in a mad rush to exit their positions because a stock is losing value.

Rookie investors are mostly interested in buying shares of companies, and they hope to see the value of their investments increase as the share price goes up. Many new stock traders also start with long positions and they are mostly interested in seeing an increase in the share price of stocks in their trading portfolio. Hence, you will find many traders and investors panicking and rushing for mad selloffs when some stocks are about to suffer a downtrend.

Instead of panicking when you see the warning signs of a downtrend on a stock, shorting stocks is one of the smartest ways to make money on a bearish stock when others are losing money, and their minds. You would have heard about shorting stocks, short selling . selling short or short trading at a point during your stock trading and investment experience.

Shorting Stocks Defined

Wikipedia defines shorting stocks as, the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them (covering).  In simple terms, I define shorting stocks as the act of borrowing a number shares to sell on the open market and then buying back the shares from the open market (at a later date) to return to the original owner. The difference in the share price of the stock when you borrow (to sell) and the share price of the stock when you (re)purchase it in order to return to the owner is your profit (or loss as the case may be).

How Shorting Stocks Work

In short, let’s assume that company XYZ is trading as $50 per share today and you (the short seller) have reasons to believe that the stock is overvalued and its share price will plummet. You ask your brokerage firm to lend you 100 shares of company XYZ and you immediately enter the open market to sell the shares to make a total of $5000 from the trade. The brokerage firm applies the loan of 100 shares of XYZ to your account; hence, you are short 100 shares (borrowed) but you now have $5000 (from the sale) in your trading account.

Four weeks later, company XYZ delivers poor earnings results and offers even poorer guidance for the next quarter. This unimpressive outlook then causes traders and investor to panic and they start selling the stock in a mad rush. Lets now assume that shares of company XYZ falls to $35 per share during the selloff. The short seller now enters the market to buy shares of company XYZ at $35 per share for a total of $3500 for the 100 shares that he had borrowed.

You now return the 100 shares of company XYZ to the brokerage firm, you need not worry about the value since you borrowed 100 shares and you have returned 100 shares. Your profit from the short selling trade is the difference between the price at which you sold the borrowed stocks and the price at which you bought them back to return (cover) your position.  Subtracting $3500 from your account to buy and return the borrowed shares will now leave a balance of $1500 (your profit) in your account before fees and commissions.

The Worst-Case Scenario

The illustration provided above is the best-case scenario in which you were right about the overvaluation of the stock and the stock plummeted after reporting an unprofitable quarter.

Now, lets assume that you considered stock XYZ overvalued at $50 per share and the company went ahead to deliver a strong earnings result and even a stronger guidance for the next quarter. The strong positivity surrounding the company generates positive vibes in the market, and investors and traders buy more shares to cause the share price of the stock to shoot to $65 per share.

Lets imagine that the original owner of the stock XYZ now wants you to return (calls away) the borrowed shares. Hence, you will be forced to go to the market and buy the 100 shares at the new $65 per share price for a total of $6500. You will remember that $5000 was applied to your account on the first trade when you sold the borrowed stocks. Hence, subtracting that $5000 at which you sold the shares from the $6500 at which you now have to repurchase the shares puts you at a loss of $1500 before adding commissions and fees.

How to Execute a Short Trade

Executing a short trade is done in practically the same way as regular trade except that shorting can only be done using margin accounts with brokerage firms. A margin account makes it possible to borrow money to buy securities and then using the bought securities as collateral. It is essential that you find the best broker  and that you understand all the margin rules, fees and charges of the broker and before you set up a margin account.

The next step is to place an order by entering the trade online or by calling your broker with your trade parameters. I have included a screenshot (below) of how to place a sample shorting order using Investopedias trade simulator .

Once your order is processed, you will see the stock listed on your portfolio summary and the shorted position will show gains when the share price of the stock is falling. Increases in the share price of the stock will show commensurate losses in the value of your shorted position.

Risks & Rewards Of Shorting Stocks

The worst-case scenario is the loudest noise that you will hear about shorting stocks because many people do not take the time to understand and manage the risks involved in shorting stocks. Shorting stocks is a high-risk and high-reward stock trading tool and it is not designed for the feeble-minded or the low-risk taker.

Nonetheless, you should note that it takes a combination and alignment of sound bearish stock fundamentals. technical analysis. and perfect timing to profit from shorting stocks. More so, even the best traders occasionally lose money when shorting stocks. The most important key is that the trades on which you make money should be more than the trades on which you lose money and you will fine shorting stocks for profit.