How Do You Make Money Shorting Stocks?

You make money when the price falls, but why and how?
Thanks..

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This entry was posted on Thursday, March 18th, 2010 at 9:28 am and is filed under Stock. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

6 Responses to “How Do You Make Money Shorting Stocks?”

  1. Before I start, I will tell you how the traditional method of making money from stocks works. The traditional way is to buy low and sell high, which is known as going long because you are trying to make money from a price increase.
    However, instead of going long, you want to go short, i.e. make money from a drop in stock price. Here is how it works:
    Let’s say the stock of Company XYZ is trading at $50 per share. An investor thinks that XYZ’s stock is overpriced and expects it to fall. The investor will then go to his broker and ask to borrow a share of XYZ (you can borrow more than one share if you want to). When the investor borrows that share from his broker, he is essentially agreeing to return that share to his broker. After acquiring a share of XYZ, the investor then sells that share for whatever it is currently trading at, and let’s assume that he sells that share for $50. Remember, the investor has to give back the share of XYZ that he borrowed but he wants to keep some money from that transaction. So he waits for a week or so and the price of XYZ drops to $40. The investor then decides that this is a good time to give back the share so he buys XYZ at $40 and then gives that share back to the broker. From this transaction, he has made a profit of $10 minus any fees associated with the short sale.
    If you look at the above situation, the investor was making money traditionally but in a different order. When you go long on a stock, you buy low FIRST and then sell high. But in the above situation where the investor was going short, he sold high first and then bought low and the gain is in the form of saved money.
    Being an investor myself, I can tell you that shorting stocks is very risky. Let’s take the same example described previously. Let’s say that after the investor sold XYZ for $50, the price shoots up to $60 the next day and enjoys a run where the stock gains money for the next few weeks. The investor ends up losing money because he has to repurchase that one share of XYZ and give it back to the broker. Also, notice that the price of XYZ can shoot up to infinity. There is no limit to how high the stock can go but there is a limit to how low the stock can go and the stock cannot go below $0. So basically, the risk is theoretically unlimited.
    You may ask who would do this. Many seasoned investors/traders do this from time to time. Usually, stocks that have been going up for a long period of time (e.g. a few weeks) will be shorted. The theory is that once a stock has had a good run, traders will want to sell in order to lock in a profit. However, short sellers essentially have to use their hunches and best judgment to decide when to short a stock. However, one ought to look at how low the stock can go because chances are that they will have to pay commissions just to make the necessary trades but may also have to pay additional fees, and all of this will eat into their profits.

  2. You’re either looking for a technical answer or a practical one. I’ll deal with the practical one.
    You really can’t, in practice, make money shorting stocks consistently over the long haul because you’re “playing the market” and that really doesn’t work. You make money by buying undervalued stock of good companies and holding it. Not forever, necessarily, but hold it long enough for it to grow into its real value. This is the system that Warren Buffet uses, and it works over the long haul very well.

  3. Jason Alexander on March 18th, 2010 at 9:08 pm

    An investor who sells stock short borrows shares from a brokerage house and sells them to another buyer. Proceeds from the sale go into the shorter’s account. He must buy those shares back (cover) at some point in time and return them to the lender.
    Thus, if you sell short 1000 shares of Gardner’s Gondolas at $20 a share, your account gets credited with $20,000. If the boats start sinking—since David Gardner, founder and CEO of VENI, knows nothing about their design—and the stock follows suit, tumbling to new lows, then you will start thinking about “covering” your short there for a very nice profit. Here’s the record of transactions if the stock falls to $8.
    Borrowed and Sold Short 1000 shares at $20: +$20,000
    Bought back and returned 1000 shares at $8: -$8,000
    Profit: + $12,000

  4. Investing Bob on March 19th, 2010 at 2:17 am

    I would never short a stock. Where you short a stock you sell the stock and buy it back later at hopefully lower price. If the price goes up you could lose a lot of money.
    I buy something called naked puts. When the price goes down the value of the puts goes up.
    When you buy a put all you can lose is the value of your original investment.

  5. You buy a short on a stock if you think it will go down in value. You can do this by setting up a margin account with a brokerage house.

  6. about it you can get information from here http://webfin4.notlong.com/5AAfFh7

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