How To Sell A Stock You Don't Own

by Larry Potter

Tonight, we want to review shorting. I don't know why but so many people become uneasy when they hear this term. I guess that occurs when there is not a clear understanding.

Shorting is used to capitalize on a drop in a stocks price rather then a rise in price. Buy a stock...goes up you make money. Short (sell) a stock...goes down you make money.

But how do I sell a stock that I do not own you may ask. You borrow the stock from your broker and sell it to someone else.

Your broker has it in inventory or they borrow it from another brokerage firm. They actually loan you the stock to sell to someone else. This is all done automatically and instantly when you place an order to short a stock.

Once you have shorted the stock (by borrowing it) you must eventually return the borrowed item...the stock, back to your broker.

You do this by placing a buy order on the stock you are holding short. The stock you buy is then returned. Again this happens instantly.

Example: You decide that stock ABC at $50 is about to go down so you want to short the stock. You click your online account "Short" button to place the order, let's say 100 shares of ABC at 50.

The price of ABC goes down for you. Let's say that ABC declines to $45. At 45 you decide that it may not decline much further, so you click your "BUY" button at your brokerage account to buy 100 shares at $45.

You shorted (sold/borrowed) the stock at 50 and bought it back at 45. You made $5 per share in profit or $500.

You sold the borrowed stock for $5000 ($50 X 100 shares) and bought it back for $4500 ($45 X 100 shares).

All the mechanics of borrowing the stock, debiting your account (when you buy), returning the stock, crediting your account (when you sell) is handled seamlessly by your broker.

Of course you can lose money if the stock goes up when you place a short order (like a stock going down when you place a buy order). That's why it is imperative to be properly prepared when entering the stock market.

The point is, do not limit yourself to making money in only ONE direction. When the market is crashing you need to be shorting stocks, not buying or holding on to your buys. And when the market is taking off, you need to be buying.

Don't limit your income potential by only purchasing stocks.

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