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The Basics Of Short Selling
Stocks
By Joseph Kenny
‘Shorting’ or short selling refers to the selling of a
contract, a bond or stock or a commodity that is not directly
owned by the seller. When practicing short selling, a seller is
committed to purchase the stock or commodity previously
sold.
Short selling stocks means to take the stock from a broker on
loan and sell it off to someone else. This is done so that the
seller buys back the stock, when the price falls. The shares
are returned to the broker from whom they were initially
borrowed. The shorting profit or the difference in price goes
to the seller. Short selling of stocks is a technique used by
investors to capitalize on a probable decline in the stock
price.
To understand this better, let us consider a company, say, ABC
whose shares currently sell at $12 each. A short seller borrows
50 shares of ABC and then sells those shares to someone else at
$12 per share, for a total of $600. Now, if in future the price
of shares of ABC falls to $10 per share, this short seller
would then buy back those 50 shares at $500 ($10 multiplied by
50 shares), send back the shares to the original owner/broker
and make a profit of $100.
Short selling is risky, if the price per share goes up instead
of declining, as expected. Suppose the price per share of ABC
goes up to $15 per share, then the short seller will have to
cash in the previously sold 50 shares at $750, return the
shares to the original owner and incur a loss of $150.
Shorting is a transaction done on margin. Most brokers do not
agree to short selling stocks below $5. This enables the
investors and short sellers to indulge in the high-risk trading
of stocks.
Some of the following market situations help to predict a fall
in price of stocks: -
- Market indexes coming near the prior resistance levels.
- Market trend showing technically overbought levels.
- Restlessness before the announcement of a state’s
government.
- Market vulnerability during scandals.
 Large volume selling of stocks often result in
short-term high profits. However, there are certain
guidelines to be followed for successful short selling.
They are:
- All stocks are not ‘short’ able. Generally, brokers inform a
seller whether a stock can be used for short selling or
not.
- Sellers must open a margin account for short selling. This
depends on the minimum balances and cash reserves. Sellers are
required to sign a contract agreement with the brokers to open
a margin account. This agreement clearly states that a seller
will follow the rules and regulations stated by the broker.
-Target bad-performance, overpriced companies, since the
probability of a fall in the share price involves lesser
risk.
- Traders and short sellers should use stop orders to protect
their capital from loss. Generally, brokers prevent a seller
from suffering loss more than the principal. They may either
compel the seller to quit the transaction or they may deposit
funds to increase the seller’s capital.
The short selling of stocks involves a lot
of discipline. Sellers need to be proactive, alert and
disciplined when shorting stocks.
About the Author: Joe Kenny writes for CardGuide.co.uk,
offering UK credit card
comparison, visit them today for more best buy credit
cards. Visit today: http://www.cardguide.co.uk/
Source: www.isnare.com
Permanent Link: http://www.isnare.com/?aid=106062&ca=Finances
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