- What is "Selling Short"?
Selling Short is confusing for
those that first hear the concept, so the following explanation
is aimed at beginners.
-
- Selling Short is the process of selling stock that you don't
own with the intent to buy it back in the future at a lower price
to make a profit. First, let's consider some concepts.
- Stock has a property that is similar to
a dollar bill. If I borrow a dollar bill from you and give a
dollar bill back to you next month, you don't care if it is the
same exact dollar bill or one of a million others because they
represent the same value. Similarly, if you gave me one share
of Intel stock it wouldn't matter if I gave you a different share
of Intel stock a month from now because it has the same value.
- People buy and hold stock which is held
at their brokerage firm. For example, if I buy 100 shares of
Intel using Penson Financial Services, my 100 shares of Intel
will be held by Penson until I sell it or until I request that
they send me the stock certificates.
- When I open a margin trading account I
agree to allow Penson Financial Services to loan my shares of
stock. If you open a cash account this is not be the case.
- You can only sell short using a margin
account.
- Suppose you trade using Penson Financial Services also. You
decide to sell short 100 shares of Intel at the current price
of $30/share because you think that the price will decline within
the next 3 weeks.
- You call Penson and enter your trade to
sell short 100 shares of Intel @ $30/share.
- The Penson sales rep then loans you my
100 shares of stock that they are holding and enters the trade
which is executed by selling my shares, that were loaned to you,
to Joe stockbuyer.
- You must, at some point, buy back the
stock that was loaned to you and you shouldn't wait too long
because you are responsible for dividends, etc.
- Although it is rare for a stock to go
from $10/share to $1000/share overnight it is possible and that
is why selling short is considered to have unlimited risk. Compare
this to buying the same stock at $10/share and having it go to
zero in which your risk is limited to $10/share.
- When you sold the stock short Penson will
have reserved $3000. ($30/share x 100) in your margin account
even though they will receive $3000. from the buying broker handling
the trade for Joe Stockbuyer.
- There are two ways this trade will turn out.
- Intel's stock price declines below $30.00.
In this case suppose the price went to $24/share in one week
and you decided to cover. Cover is the term used for the act
of buying the same number of shares of the same stock that was
sold short and it must be done in the same account. This is why
you sold the stock short in the first place - a profit of $6/share
or $600.
- Intel's stock price goes up over $30/share.
Now, this is not good for your trading account, but you should
have a stop set, so you don't go too deep into a losing position.
Suppose your stop was set at $32/share and the price went to
$32/share. You would cover your position and have a loss of $2/share
or $200.
- When daytrading using Realtick Software, you simply click the
"short" box and then sell the stock. The software automatically
knows it is a short sale as long as you don't own it in the same
account. If it is not available for selling short, you will receive
a message stating so.
-
- I hope you now have a better understanding of how and
why people sell short. One more tip I think you should consider.
Selling short while daytrading gives you control of when you
will cover your trade. Holding a short position overnight introduces
additional risk beyond your control.
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- Learning to trade is no simple task due to the skills and education
necessary. If you think that you've learned enough and are ready
to trade I hate to rain on your parade, but you are trying to
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professionals make a living. You know the old saying, "
you can lead a horse to the water, but you can't make him drink".
Well, I'm leading you to the training courses you need, but only
you can drink.
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- There are 2 main reasons why I take the time to publish this newsletter.
The first is to share my knowledge with fellow traders because
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