Lesson 1

As a natural instinct we are long on stocks, bullish by nature. BUT! With the blood flowing so freely lately with the volatility in the market. The subject of shorting stock must be an option so that we can make money no matter what is happening in the market.

This has been a question that hundreds of our readers have asked about. When the market turns against you a clear understanding of the process involved with shorting stock can make big profits while you wait for the market to rebound. But you must be fast on the keyboard, and AWARE of your pricing!

Shorting Stocks 101


Shorting stocks is a method of gambling on a stock whose price you think will decline. Instead of purchasing shares of a stock you think is going up in price, you instead borrow shares, sell them immediately, wait for the price to go down, and then buy them at the lower price and return the shares to the broker. The advantage of shorting stocks is that you can make a profit without an initial cash investment. For example, suppose you think the price of SOAP stock is going to go down from its current price of $32. You tell your broker that you want to sell short 200 shares of SOAP stock. (You must have a margin account to short stocks.) Your broker then borrows 200 shares of SOAP and sells them for you, depositing $6400 in your margin account. MONEY!!! BUT... you hope that the price goes down because eventually, you need to return the 200 borrowed shares to your broker. Suppose that the price does go down to $25. You can now buy 200 shares of SOAP for $5000, return the 200 shares to your broker, and pocket the $1400 profit ($6400 - $5000) minus the commission. You've made money without an initial cash investment. However, shorting stocks is considered riskier than buying stocks because the stock of the price could go UP an unlimited amount, resulting in unlimited losses. At some point, you need to buy the shares you borrowed to short the stock. For example, if the price of SOAP goes up to $40, you would have to pay $8000 to buy the 200 shares owed to your broker. In this case, you would lose $1600 ($8000 - $6400) plus the commission. Because shorting stocks involves an unlimited risk, the SEC has special regulations requiring brokers to issue a margin call when an investor's losses reach a certain amount.
Remember The Margin Call? When an investor has bought stocks on margin and the value of that stock falls too low, the broker may issue a margin call to the investor to obtain money to cover the decline. Stock exchanges, the National Association of Securities Dealers (NASD), and individual brokerages have established rules governing the percentage of a purchase that can be made on margin.