The stock market can be a confusing place, even for the veteran if they are wading into a new area. The act of selling what you do not own may sound strange, but that is the easiest way to have selling short explained. This article will detail the concept of how to short stocks, as well as the benefits and dangers that go along with the venture. Shorting stocks may sound backwards, but it turns out to be just another way to invest your money based off how you feel the market will change.
What is Short Selling?
When selling short, you are selling stock that you do not own. Your broker is lending you stocks that they own, another firm owns, or possibly one from a customer like yourself; this is one reason that opening multiple accounts is important, because it will increase your available options when shorting stocks. Once your borrowed stock has sold, you are responsible for buying it back and returning the shares with the goal of waiting until the price goes down. Often the time limit for buying the stock back is not set, but interest is often charged; this means that the longer you wait to buy back the more you will owe.
The Dangers of Selling Short
When you go long on a stock, you are hoping the price will rise over time and you will make a solid return on your investment. If a stock’s value goes down, then you are stuck with the choice of waiting it out until it goes back out or just cutting your loses. If a stock is valued at $100 and you buy 100 shares, the largest loss you expect is $10,000 if the stock goes under; this isn’t true with shorting stocks, because you could sell the stock at $100 a share and due to a miracle breakthrough the value of the stock doubles, triples, or even worse.
Benefits of Short Selling Explained
The major benefit is obvious: When you know a company is going down, you can make a profit off their pitfall; this sounds a bit immoral, but when it comes to the stock market, you are fighting to survive in shark infested waters. If you have done a lot of research about a company and found they are on a downturn, you can use short stocks to make money off the time you spent researching, instead of chalking the company up as another dud and moving onto the next. Flexibility is the primary advantage when it comes to this type of transaction
Should You Enter the Short Stock Game?
Learning how to short stocks may seem like just another tool in your kit for making money from the stock market, but it is not something to enter lightly. The possible losses are exponential and can far exceed your initial investment if you make a mistake. Most people who dabble in the stock market think to themselves, “I’m only investing $500, if I lose it, I lose it.” Shorting stocks can turn that $500 investment into a $5,000 bill if you are not careful with what you are doing.