Short Selling: The Transaction



Assuming that after few hours of careful investigation and study, you decided that the ABC company is dead in the water. Let’s say the stock is recently trading at $65, but you anticipated it will trade much lesser in the coming months. To be able to capitalize on the drop, you decided to short sell shares  of ABC stock. Let’s check how this transaction would reveal.

Step A : Create a margin account, keep in mind that this account allows you to borrow money from the brokerage firm by means of your investment as a warranty.

Step B :Put your order by calling up the broker or entering your  trade online. Majority of  online brokerages  will have a check box that says “short sale” and “buy to cover.” In this situation, you  decide to place in your order to short 100 shares.

Step C: Depending on availability, the broker, borrows the shares.  According to the SEC, the stock shares the company borrows can come from:

     *The brokerage firm’s own inventory

     *The margin account of one of the firm’s clients

     *Another brokerage firm

You should be aware of the margin rules, as well and know that payments and charges may apply. For example, if the stock shares have a dividend, you have to pay the person or firm making that credit.

Step D: The broker sells the stock shares in the open market. The revenues of the sale are then placed into your margin account.

Any of these two can happen in the coming months: 

 

Evidently, short selling can be profitable, however, there is no assurance that the price of a stock shares wil go the way you anticipated it to (same with Buying Long).

Short sellers practice an endless figure of metrics and ratios to find shortable candidates. Others use similar stock picking methodology to the longs, but only short the stocks that come out poorest. Some look for insider trading, changes in accounting policy.

One specific indicator to Shorts that is worth stating is short interest. Short interest is the complete number of stocks, securities or commodity shares in an account or in the markets that have been sold short, but have not been repurchased in order to close the short position. It functions as a barometer for a bearish or bullish market. For example, the higher the short interest is, the more the trader will anticipate a decline.

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