How to Short a Stock and Win
We go to the mailbag and answer the most popular question for the last few months -- how do you short a stock and make money? What is short selling and how can you get burned? Mastery has got your back including a video to get you started.
APPROVAL IN YOUR TRADING ACCOUNT TO SHORT STOCKS
No matter who you trade with be it Scottrade, ETRADE, TD Ameritrade etc. you need permission from your broker to short stocks. This means you need to sign something be it electronic or actual physical form that you then have to mail in that enables you to have margin privilege.
Margin privilege is borrowing and trading on a margin which involves benefits and risks, particularly in volatile markets. These include the risk of losing more funds than you deposit in the margin account. If the value of the investments in your margined account falls, you could get a maintenance call. On maintenance calls, you are not entitled to extension of time.
EXAMPLE OF SHORTING A STOCK
The stock we are shorting is the ABC Company, that trades under the ticker 'ABC'. This is not a real company, just using it for the example. ABC trades for $10 a share.
You decide to short sell 1,000 shares by borrowing $10,000 worth of ABC shares ($10 share price mult. by 1,000 shares) from your broker in your online trading account. You sell the 1,000 borrowed shares on the market and keep the cash.
Important: You don't own the stock you're short selling (you borrowed and then sold it). Thus you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stock splits during the course of your short, you'll owe twice the number of shares at half the price.
You hope that the price of ABC shares will fall. Then you will be able to buy the shares at a lower price and return them to your broker, pocketing the difference. Ex. ABC falls to $7 per share, you could repurchase the 1,000 shares for $7,000 by placing a buy to cover order, return them to your broker and pocket the $3,000 profit. (The buy to cover order is not the same as a regular market order; it effectively returns the borrowed shares to your broker and must be used to close your short position.)
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