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What Is Shorting Stocks?

December 19, 2005
by Cory Bain
Choose To Be Rich

The whole idea of shorting stocks is to make money from stocks that are going down in price. When you short stocks, you are essentially selling stocks that you have borrowed, in other words you do not personally own them.

First, you need to have a margin account in order to sell stocks short. A margin account allows the broker to extend credit to you, based on Federal guidelines. You must have at least 50% of the amount involved in short selling the stock as cash in your account. This shows that you have sufficient funds available to buy the stock back should it go against you. Lets look at an example:

ZYX Co. is trading at $23.00

You would need $1150 in your account to short sell 100 shares. You would receive a credit of $2300 less commissions. Overall, you would have a credit balance of $3450 in your account.

ZYX Co. goes to $18.00

You've made $500. Your credit balance is still $3450, but the market value of the stock is only $1800. So your equity is $1650 ($3450-$1800). Your paper profit at this point is $500.

Although you will always pay interest on money you borrow from the broker, you may be able to negotiate a better rate if you're a preferred client or have a sizable account. You will also be charged by the broker for any cash or dividend payments on your short positions.

Assuming you are an average person without any insider information, the best time to short sell in general, is when the overall stock market is in a down trend. Even the best stocks go down in Bear Markets. If you're just starting out, take small short positions, never short a stock that is rising in price, and use stop-losses to avoid big losses on your short positions.
To learn more about various investing topics, checkout the author's website. This article and others by Cory can be found at his website. Choose To Be Rich


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