To a novice investor, short selling sounds like one of those sophisticated, mysterious techniques that professional traders use to rob others blind. In reality, anyone can short a stock and make a profit if the stock drops in price.Short selling can be a powerful tool in your investment toolbox, but you need to understand the operator’s manual before you use this tool. Try to short a stock the wrong way and you could drill a hole in your own hand.
What is short selling?
Every investor understands the conventional way to make money in the stock market (if they don’t, they shouldn’t be in the market!). You buy a stock today, wait for its price to go higher than you paid, and then sell it for a profit. This is known as being “long” the stock. Pretty straightforward.
Short selling is the same process in reverse. You sell a stock today, wait for the price to fall below what you paid, and then buy it at a lower price. This is known as being “short” a stock, or short selling. Sounds a little weird and complex at first, but it’s actually rather simple to do as I explain next.
When you are long a stock, your goal is to buy low and sell high.
When you are short a stock, you want to sell high and buy low.
How do you sell a stock you don’t own?
The quick answer is you borrow the stock.
How do you do this? Your broker will locate shares for you to borrow. In fact, many brokers require you to borrow shares before they will accept your short sell order. When your broker fills a short sell order for you, another investor agrees to buy the shares from you. It’s your responsibility to deliver the shares to the broker by settlement date—normally three business days later. The graphic below makes it easy to grasp the procedure.
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