Short Selling Stocks

Does the economy have you down? Do you want to invest but don’t have the money? Are you looking for a way to successfully invest in the sinking market? Well, the investing practice of “short selling stocks” might be your answer.

Now, I preface this by stating that short selling stocks is considered somewhat of an advanced technique, so you might want to contact an advisor before jumping in headfirst. The reward can be great, but as always with investing, risk plays a huge role.

The principal idea behind short selling is contrary to mainstream investing, i.e., buy low, sell high. In almost bizarro-like fashion, you buy high and sell low. Sound strange? Good, it should. After researching a stock that you believe to be overvalued, you borrow shares you don’t own from your broker, order them sold, and take the money. Then, you enter the most critical stage of the process. Exciting to some, excruciating to others, this is the time you wait for the price of the stock to drop. If you are correct in your assumption and the price drops, say a quick prayer of thanks, buy the shares at the lower price, turn them over to your broker, and keep the profit.

To illustrate this further, lets say you could sell short 100 shares at $20 a share. Say the price drops to $15. You buy 100 shares at that price and return them to your broker, pocketing the $500 difference minus commissions. So, since you sold the shares for more than you originally paid, you came out on top and didn’t have to use any of your hard-earned cash. Yeah!

Sound simple? Well, it’s really not. Short selling stocks has some inherent problems. First, you have a limited profit potential. Since the stock price cannot drop below $0, you only have from the starting price down to gain. Also with this limitation, selecting low-priced stocks don’t offer much of a gain unless you buy a large number of shares. Second, and most importantly, the price of the shares could go up! Again, an increase of the stock’s price is the adverse of what you want to occur. In this disastrous situation, you’re obligated to replace the shares that you borrowed at a higher price than you paid for them.  Contrary to the recent stock market activity, it actually goes up more often than it goes down.

Another negative is the “squeeze”. This occurs when a heavily shorted stock starts to increase in value, as stated above. Short sellers begin to panic in an attempt to cover their positions. The price ultimately is driven up higher due to the heavy buying. In this situation, you are responsible for the difference as well. Ouch.

Don’t get discouraged, however. Short selling has been in practice for over 400 years and is a widely used investing technique. Short selling is also said to keep the market honest with the idea of balancing the market with investors who will do anything to have their stocks go up with investors who are driven to do the opposite.

There’s also version of short selling stocks called naked short selling, and no, it’s not short selling shares in the comfort of your own home at your computer.  It’s an illegal short sale that occurs before the seller has actually borrowed the stock. So it’s not only selling something you don’t own (short selling), it’s selling something that may not even exist. Don’t do this.

So, if you’re looking for a way to protect your assets and make some money in this downward spiral of an economy, try high-interest money markets. If you are an aggressive investor that has completed the appropriate research and is looking for an exciting way achieve profit in a bear market, short selling stocks might be for you. Pepcid is on aisle five.