Selling short?

I’m relatively new to the stock market, but I’ve come to realize that some people see the news that a public company has a yet to become widely known hole under the waterline as an opportunity to make money by “going short”.

How does this work?

Essentially, you borrow shares of the target company and sell them. At some point in the future, you buy shares back and return them to the party from whom you borrowed them. If the shares have gone down, you make money. The opposite is also true.

From whom do you borrow the shares? Banks and brokerage firms, who hold others’ shares in “street name,” which is to say in their name on behalf of the ultimate customer. If you have a margin account, you have signed an agreement allowing your brokerage firm to loan your shares to others.

A note of caution. This is an unbelievably difficult way to make money. Even bad companies often see share price increases. In a bull market like we’ve had over the past several years, I’ve seen some very smart shorts get their heads (and walking papers) handed to them. Be careful.

Livin’ on Tums, Vitamin E and Rogaine

The worst thing about short selling is that it has a limited upside but, at least theoretically, an unlimited downside. For example, if I short 100 shares of ABC, Co. at $10 per share, the most I can make is $1000 - and that requires the share price to go to zero. OTOH, the price could rise forever, costing me a potentially unlimited amount of money.

To make things worse, the upside above ignores things like brokers fees and interest, which tend to eat into earnings.

The overwhelming majority of people have more than the average (mean) number of legs. – E. Grebenik

So what you’re saying, Dr. J., is that if you sell shorts, you’re apt to lose yours? :slight_smile:

Yep! There’s no limit to upside.
That means that short selling allows you to lose more than 100% of your money.