Short Selling Stocks – A Quick Guide

by Heath Derkins on Thursday, February 4th, 2010 | No Comments

Basically, short selling of stocks refers the selling of a stock not necessarily owned by the seller. To be more specific, it is the short sale of a security that the seller does not own but promises to deliver anyway. When you short sell a stock, you must have a broker who lends it to you. The stock may come from the brokerage firm’s own inventory, from another brokerage firm, or from one of your brokerage firm’s customers.

When the sale transaction is consummated, the proceeds are deposited into your account. Soon or later, you will be required to “close” the short. Closing the short is accomplished by purchasing the identical number of shares and returning them to whomever lent them to you in the first place. At the time of the purchase closing the short, if the price of the shares is less than when you sold it, you have a profit. Short sellers have a loss when the subsequent price has risen above where it was when the stock was shorted.

You need a broker if you are going to try to play with stocks, especially if you want to short sell. In order to use a broker for your stock dealings, you need to open an account with the firm from where the broker is located. If you open an account with cash, money is directly taken from your account to pay for any purchase. If you open a margin account, you do not need to pay for the purchase directly, and can borrow funds from the firm at the time of the transaction. The account is set up as a way to cover your activity.

In reality, you do not own the stock that you are short selling as you borrowed it prior to selling it. So you must pay the official owner any dividends or rights declared while your sale is open. For example, should the stock splits two-for-one while you have the loan, you will owe the lender twice the number of shares than what you borrowed.

Short selling is a risky business and should only be undertaken by someone is very familiar with the way stocks work. There is no limit in the amount of money you could lose n short selling stocks. By comparison, with regular stock, the maximum you can lose is only what you put into the stock. For most people in the stock market, they always hope for a gain, but when short selling stock, sellers actually want the stock market to do poorly.

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