Shorting Stocks

By Eric Armenteros

Everyone has their finance guy they go to, well this is mine. Eric is a financial advisor currently working for Citi and holds a series 7 license. He will periodically be sharing his thoughts on the market.

The other way to make money in the markets. A basic description of shorting stocks.

Selling something you don’t own and profiting from it is something that amateur investors sometimes have a hard time understanding. This is precisely what happens when you “short” a stock. You’re basically anticipating a downward move in your position and stand to profit from that decline. How does it work? Quite simple actually:

What you first do is “borrow” a fixed amount of shares, say 100 shares of ABC company at $100 per share, from your brokerage firm (E-Trade, Ameritrade, Scottrade, etc). Now, you’ve automatically placed yourself in debt with your brokerage company for said amount of shares (this is important to understand, since most place a focus on the value of the shares instead of the shares themselves).

What you then do is sell those shares in the market for the current market price ($100 from above) to net $10,000 total- these proceeds are automatically placed in your account. However, keep in mind that you still “owe” your brokerage company the shares you borrowed.

As you anticipated, the price of ABC company falls- let’s say to $50 per share. What the investor then does is “buy” those shares back from the market using their $10,000 from before; however since the shares depreciated in price, the overall cost of the same 100 shares at $50 per share is now $5,000.

Lastly, you return the 100 shares borrowed to your brokerage company and realize an overall profit of $5,000, and there you have it. You’ve successfully shorted a stock.

Shorting stocks tends to be a popular investing strategy in a bear market since the prices of stocks have a greater chance of falling more often.

* Shorting can be very dangerous since theoretically, a stock can go up in value to infinity; however, the price can only depreciate to zero. Make sure you know what you’re doing before shorting a stock.