Shorting A Stock: Beginner’s Guide To The Top Investment Strategy

shorting-a-stock-guide

Shorting a stock, also known as short selling, is a controversial means of trading stock on Wall Street. If you are a new investor, you may not yet be familiar with the risks associated with this type of transaction. Shorting a stock is a calculated game of chance. Even college dropouts can earn millions using this trading technique. It is important to understand the process of short selling and its possible outcomes, especially if you are new to the industry. Below, we have outlined the process of shorting a stock as well as some additional key information you may need to know.

Sell High, Buy Low

You have no doubt heard the phrase “Buy low, sell high.” Well, shorting a stock works in reverse. This is the process of selling stock that you think is overpriced, waiting for the price to drop and then buying it back at a lower cost. The key to making money on this type of transaction is outlined below.

Borrowing

In order to sell high and buy low, you are going to need some overpriced stock, like stock for companies in Denver. Rather than selling stocks that you already own, which would not make you any money in the long run, you need to borrow stock from other investors and brokers. When you borrow a stock to short sell it you are essentially selling something that you do not own. To learn more about the risks associated with this process, keep reading below.

Risks

Short selling a stock requires the acceptance of risk. The point of shorting a stock is to borrow something at a high price, which could ultimately lead to you losing money. If you borrow and sell a stock at $10, hoping that it will drop to $5 so that you can sell it to make a profit, there is also a chance that the stock could jump to $20. This means that you would need to repurchase the stock for twice as much as you originally paid for it in order to return it to the owner. However, many investors accept this risk for a few reasons.

Speculation

Speculation is one of the main reasons that investors and brokers partake in short selling. This is when they “speculate” that a certain stock is going to drop in price in the near future. Before the stock drops, they will then borrow it at a higher price and sell it so that, when the price goes down, they can return the shares and pocket the difference. Often, the anticipation of negative news or events that could potentially harm a stock require thorough research, intuition and excellent timing.

Hedging

Hedging is another reason that investors may choose to short sell a stock. A “hedge” acts as insurance, protecting you from some kind of potential loss. This is the process of locking in shares of a stock at a particular price. This technique is called “shorting against the box.” When you lock in a stock price, you will still earn a profit if shares go down, but you offset your losses with shares you already own if it goes up.

Shorting a stock is a risky process on Wall Street. However, with the proper preparation it can help investors make a relatively easy profit. Whether you are interested in partaking in short selling, or you just want to avoid it all together, this post can help you recognize the process and do whatever is best for you.

Photo from http://money.usnews.com/money/personal-finance/mutual-funds/articles/2015/11/02/why-shorting-stocks-may-be-a-huge-mistake

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