This post is a result of Mystery Blogger IP force...Long Buying Stock or Short Selling Stock?
When most people think of taking a position in a stock, they probably think of buying and holding. The objective of their “buy and hold” strategy would be a rise in the price of their chosen stock and for some, to collect a quarterly dividend. This position is known as being “long”.
Most people have no idea that they can take the exact opposite position and profit from a drop in price. This strategy is known as having a “short” position or “selling short”. When you buy a stock or invest in a mutual fund, your account appreciates when the stock, or stocks in the case of the mutual fund, increases in value. Most of America understands this premise as the only way one can invest.
Experienced traders on the other hand, know the profit potential gained by selling short! Instead of riding the market down with long positions (which is typical of most investors), they take a short position and profit when the market is in a downtrend! To sell short is to sell a stock that you don’t own. The position is opened by a sale instead of a purchase.
Short Selling Stock
Therefore, short selling stock is where you profit if the price of the stock drops. For example, if you think stock XYZ price has reached a peak, and will soon begin to fall, you could short sell XYZ. You would sell the stock at the current stock bid price, even though you don’t own, or have never purchased, and shares of XYZ stock. However, to cover this short selling stock transaction, you are required to have stock margin, which is sort of like a loan.
Let’s say XYZ stock is trading for $20/share. You don’t want to purchase the stock at this price because you think the stock price is about to drop. So you sell short XYZ at $20/share instead, which means this stock investment is worth, and always will be worth, $20/share, regardless what the stock is actually trading for in the future.
This allows you to sell, anytime you chose, the XYZ shares for $20/share. So in essence, you know the stock selling price. To complete the stock transaction, at some point you will purchase this stock at the current trading ask price. Therefore, you want the stock price to be lower than $20/share, because you are buying the stock for which, your selling price is set at $20/share.
Short selling stock transaction example
You decide to sell short 100 shares of XYZ stock at $20/share, for a total of $2000.
Your stock brokerage firm credits $2000 of XYZ stock margin to your account, for which you are financially obligated to ‘repay’. The ‘repay’ amount is determined by the share price you pay to buy XYZ stock in the future.
Two weeks later XYZ ask price is $15/share, so you decide to buy 100 shares at that price, for a total of $1500. The brokerage firm debits the 100 shares of XYZ stock margin from your account for the ‘repay’ amount of $1500, and this investment has left a $500 profit in your account.
BUT…
If two weeks later the XYZ ask price is $25/share, to buy 100 shares at that price will cost a total of $2500. The brokerage firm would then debit the 100 shares of XYZ stock margin from the account for the $2500 ‘repay’ amount, and this investment would leave the account with in a $500 loss.
(note: The two week time frame was used as an example and has no significance. This closing transaction can occur whenever the trader decides the time is right.)
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