Short Selling Made Simple

Short selling is one of the hardest things for novice investors to understand as selling something you do not own really doesn’t make sense but the easiest way to understand short selling is to think of it as just the opposite of buying a stock. When you short sell a stock you are selling the a stock that you are basically borrowing and will buy at a later date hopefully at a lower price.

If you were to short sell xyz company for 1000 shares @ $10 you are hoping that when you buy it or cover your short the price will be lower than $10 per share. If XYZ falls to $9 a share and you feel its time to cover your short you will have made $1000 (Initial XYZ Sale  Price $10,000 - $9000 price to purchase stock)not including relating fees.

Short selling can be very risky since your loss is really only limited to the size of your account, it can potentially wipe out your account if it were not limited by margin. This is due to the fact that a stocks upside has no limit but a stocks downside is limited to zero. So if you were to invest $10,000 in XYZ and in went to zero your return would be $10,000. If on the other hand XYZ went to $150 a share and you had to cover at that point your loss would be $140,000. This dichotomy makes short selling very risky and not for the faint of heart.

More Short Selling Notes

• The short seller must pay any interest 0n the borrowed stock until the short is covered.
• Short seller is responsible for paying dividends to whom the stock is  borrowed from.
• Naked Short selling can have very high margin requirements.