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Shorting Out the Market
9 years ago
General
It's pretty easy to understand how to make money on a stock when the value goes up. You buy low, sell high and profit follows. But did you know there's a way to make money when a stock loses value? It's called "Selling Short" and at first glance it sounds like magic. The stock value goes down, but you make money from that? How on earth does that work? Once you understand it, it makes perfect sense.
Say you want to short WidgetTech because you think they didn't do so well this year and when they announce that at their annual report, the stock will take a hit. Of course you don't know any of that for sure, because that would be insider trading and that's a whole other legal kettle of fish. Right now WidgetTech is trading at $50 a share and you want to short 10 shares. You find a broker willing to write up the deal and what they do is pay you the money up front in exchange for you giving them the shares later. They give you $500 and you owe them 10 shares of WidgetTech sometime in the future. Simple.
WidgetTech releases their annual report and sure enough, earnings aren't as good as projected. The stock takes a hit and slumps to $40 a share. At this point, you can buy 10 shares of WidgetTech for $40 a share and give those shares back to the broker. They originally paid you $500 and you spent $400 buying the shares to give back to them. $100 profit!
But wait... let's say WidgetTech gives their annual report and earnings are a little less than projected but they've got a hot new widget in the works that's generating serious buzz! The stock value rachets up to $75 a share! Uh oh, now you could be looking at paying $750 to buy the shares to give back to the broker. $250 loss! You are allowed to keep holding on to your shorted shares in the hopes that the value will sink back down but if the value rises too much and the broker gets antsy about your ability to keep your end of the deal, they might call in their makers and require you to pay up. Similarly they probably won't let you hold off for years before giving back the shares.
Abd that's all there is to it. No magic, but more like a delayed delivery on shares that were purchased. Theoretically with the right combination of standard stock buys and shorts, you could make money no matter which way the market swings.
Say you want to short WidgetTech because you think they didn't do so well this year and when they announce that at their annual report, the stock will take a hit. Of course you don't know any of that for sure, because that would be insider trading and that's a whole other legal kettle of fish. Right now WidgetTech is trading at $50 a share and you want to short 10 shares. You find a broker willing to write up the deal and what they do is pay you the money up front in exchange for you giving them the shares later. They give you $500 and you owe them 10 shares of WidgetTech sometime in the future. Simple.
WidgetTech releases their annual report and sure enough, earnings aren't as good as projected. The stock takes a hit and slumps to $40 a share. At this point, you can buy 10 shares of WidgetTech for $40 a share and give those shares back to the broker. They originally paid you $500 and you spent $400 buying the shares to give back to them. $100 profit!
But wait... let's say WidgetTech gives their annual report and earnings are a little less than projected but they've got a hot new widget in the works that's generating serious buzz! The stock value rachets up to $75 a share! Uh oh, now you could be looking at paying $750 to buy the shares to give back to the broker. $250 loss! You are allowed to keep holding on to your shorted shares in the hopes that the value will sink back down but if the value rises too much and the broker gets antsy about your ability to keep your end of the deal, they might call in their makers and require you to pay up. Similarly they probably won't let you hold off for years before giving back the shares.
Abd that's all there is to it. No magic, but more like a delayed delivery on shares that were purchased. Theoretically with the right combination of standard stock buys and shorts, you could make money no matter which way the market swings.
