Short Selling

Buying and holding stocks is all well and good in a Bull market when the majority of stocks are moving up in price. Even in a Bear market there are a few good deals to find but the majority of stocks are heading in the wrong direction. But there is another method that can be employed and that is short selling. Short selling makes money even though the price of the stock is going down...in fact...it is a necessity.

In normal stock buying and selling, a stock is bought at a low price and then hopefully sold at a higher price. The difference in stock price from when it was bought to when it was sold is the profit to the investor. Short selling reverses the process. The stock is still bought low and sold high...the order of the two is just switched.

Example: You sell 100 shares of XYZ at $35 a share and $3500 is deposited into your brokerage account less commissions. These 100 shares were borrowed from your broker and must be paid back. Some time later XYZ has fallen to $25 a share and you decide to close out your position. You purchase 100 shares of XYZ at $25 using $2500 from your brokerage account less commissions. The remainder, nearly $1000, is your profit on the deal.

Life is not all sunshine and roses with a short sale however. In order to do short selling you must first establish a margin account with your broker. To maintain your account you must have in your account at least 50% of the funds required to buy back the shares at the current market price. If the market price of XYZ increases after the initial sale the brokerage firm may compell you to place enough funds into your account to cover the difference. This is called a Margin Call. Also, not just any stock can be sold short. Before the stock can be sold short it must first increase in price. If your stock pays a dividend during the period the stock is sold short your brokerage firm will require you to pay this dividend to the brokerage firm. This is truly gambling.

The best stocks to sell short are those that are over-priced, have poor financial situations or cannot compete in their marketplaces. Symptoms of these stocks can include decreasing earnings per share, cessation of dividends, lower profit margins, reduced cash flows and rising accounts receivables. Also, there may also be word in financial trade publications indicating problems for a particular company.

Short selling is extremely risky with virtually unlimited risk. Only the experts should involve themselves in this playground.

Profits-Prophet.com