What does it mean to short a stock?

Answer 1

bearishShorting a stock means to sell it first then buy it back after the market (or that stock in particular) goes down. Short sells are bearish on the market, believing that the market will be going down and that they can make money buy "shorting". Sell first, buy back later at a lower cost, hence buying low and sell higher but i reverse order. Shorting can considered somewhat more aggressive because you can lose a fair amount of money if the stock does not go down but insetad goes up. You then have to "cover your short" by buying at an even higher price. AnswerHI! I'm going to offer the most basic information regarding this question, as the answer can really get complicated for the non-licensed brokers out there who are interested in investing and shorting stock.

When you buy stocks, shares (an investment) in a company making them available to the general public, you must have all the money necessary to cover those shares at the time of purchase. Stocks are sold in lots; meaning, they are sold in say, bundles, of 100. So, for example, one would see a company listing their stock at $30. That means $30 per share. So the buyer knows they have to multiply that figure by 100. Hence, a lot, or 100 shares, of Company X's stock being sold at $30/per share, would cost $300.

CORRECTION

100 x $30 = $3,000.

K, that's the basics for purchasing one lot of stock, but oftimes, people investing purchase much more than 1 lot of shares in a company. So you can imagine how expensive it can get the more shares you buy.

Had to Amend HereNow, for traders who have a feeling that the price of a particular stock will go down, the SEC (Securities and Exchange Commission) allows for the selling of shares not yet owned by an investor. How do you sell something you don't own? You do so on the promise that the shares will be delivered at a specified time in the near future. There are only ever a certain number of shares available for short selling, and an investor needs to ask his/her broker whether the short stock of interest is available to short. If the short shares are available, the broker will lend the short shares to an investor, placing them in his/her account. But hold up! It's really not all that easy. An investor needs a Margin account to be able to short sell stock. And, it can get really tricky if one is unaware of the terms and conditions of trading on Margin.

What is Margin? First of all, an investor must apply for a margin account at the brokerage that is handling their trading account. This involves a review of a person's trading history; i.e., how long they have been trading, the individual's credit history, and their net worth (the amount of securities a person has/or will have in their margin account, as well as the amount of liquid worth (cash on hand that is not tied up in stock or other securities, and that can be no less than $100,000 in a marginable account). There are then certain conditions that must be met to maintain a margin account. For example, should the margin account drop below 100K, the broker will send a margin call to the account holder, which gives the trader 24 hours to bring the cash balance in the account back up to 100K, even if that means selling some of the shares of stock in the account. Stocks are the only security that may be margined.

Once the brokerage firm's manager approves the trader for trading on margin, they must make available to said trader the rules and regulations of buying stock on margin. This is an SEC mandate. K, I'll go as far as to tell you that short selling stock requires that a trader meet initial Margin Requirements. That is to say, 50% (set by the SEC, but a brokerage can charge more) of the total purchase price of the shares, determined by the price the stock is trading at the time the stock was sold short. And, there are other rules that must be followed by the trader who short sells stock, i.e., the "plus-tick" or "short sale" rule, which simply means that a stock may only be short sold when it is trading up, i.e., during a rising market. This is to prevent excessive boiler room short sales that force the price of the stock to go down. Depending on supply and demand of short (borrowed) shares, a trader can hold the short shares in his/her account until a time when the price of the stock drops below the price at which the shares were sold short to him/her. Then the investor would Buy to Cover the short shares (rule: sell short, buy to cover) at the then current stock price and make a profit.

Completely ReworkedK, had to fix this up everyone. It's been some time since I've worked at a brokerage. So last, but not least, and considering the last statement above, what might the implications of trading on margin be? Well, this is where things can get really scary for a trader!!! Jeez, and I'll try to make this simple as possible, cuz there is really so very much to the game of trading on margin. Say, for example, I want to short 100 shares of Company X's stock trading at $25. The total purchase price of those shares would be...? Right, $2500. That means that I short sell the shares for $2500 and the brokerage firm will place the short sold stock into my account. It might even look like this under the Cost column of your portfolio: -$2500. Then, it's a waiting game...a tense one at that!!

Considering what you've read to now, what might you guess an investor trading on margin is hoping? Hope you said that the price of the stock will go down?!! Let me explain why: Say that Company X's stock is trading at $30 by market close the day we shorted our stock. The stock would have gone up $5/per share and the 100 shares we shorted would now be worth $3000. If we were to Buy to Cover the short shares in our account, we would have to buy them back for $500 more than the price at which the stock was trading when the short shares were put to us (placed in our account), and we'd be the big losers at the party. Especially if we didn't have enough cash to cover the whole purchase of the short shares, because we would have to sell some other securities in our account to close out the trade. OK, but wait. Say the stock was trading up two hours before market closed, but at close, the price of the stock drops and is trading at $15. Now the shares that were sold short to us at $2500, are now worth $1500; meaning, were we to Buy to Cover the shares at this price, we would only have to pay $1500, and the difference would be our profit. Thus, you see the scary part of trading on margin.

Sorry this took so long. Your question was awesome, and I hope this helped you understand a little bit better, but this long answer is but one of the reasons that you'll hear people talk about the volatility and risk involved with trading. For more info, I suggest you visit Investopedia.com and you can go straight to the source, the SEC website is really great for the newbie AND the seasoned investor. Here's a link to the various search results relative to Margin and Short Selling on the Investopedia website:

http://www.investopedia.com/search/results.aspx?q=margin

http://www.investopedia.com/university/shortselling/shortselling1.asp

All the very best!!!

AnswerShort selling stocks is the most misunderstood and under-utilized of stock trading techniques.

The idea of making money because of a stock price dropping, seems very foreign and down-right doesn't seem to make sense to most people.

Many stock investors feel it's un-ethical to sell short. They seem to believe we have to root for our companies to do well. Since most people in the markets have a natural tendency toward optimism, selling short is often viewed as being negative.

The fact is, there is absolutely nothing wrong with recognizing the reality of both the marketplace and economy.

Cycles are a fact of life. In the same way that it's rational to sell and avoid a large loss when a stock starts to decline, it's also reasonable to profit from that decline.

So what is short selling?

Selling stocks short is placing a sell order for shares you do NOT currently own, in the expectation that the share price will drop in the future.

For example, if you sell short company XYZ at $30, you simply borrow the shares from your stock broker for delivery to another buyer. If XYZ drops to $20, you then buy XYZ stock shares to replace those you owe your broker.

And in the process you make $10 a share.

So who says you cannot make money in a bear market?

It's a statistical fact that stocks decline faster than they rise. The reason being because fear causes a panic reaction, while greed takes time to simmer.

So if you learn the rules for short selling stock and learn to use the proper tools, great profits can be yours!