What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


How to Buy Stock Shorts

Original post by Jonathan Langsdorf of Demand Media

The term buying stock shorts is not commonly used. In this trading strategy, stocks are said to be sold short. Then the shares must eventually be repurchased to cover the short position. Selling shares short attempts to profit from a declining share price. Shares are sold short and the current price and repurchased at a lower price. The profit is the difference between the selling and repurchase prices. Traders follow a strict set of rules to sell stocks short.

Step 1

Open a margin account with an online discount broker. A margin brokerage account allows an investor to borrow a portion of the cost of stock in the form of a margin loan. Margin accounts also allow traders to borrow shares to sell short. Smart Money magazine and Barron's publish annual broker reviews rating the online brokers and discussing costs and services.

Step 2

Select a stock or stocks you believe will decline in value. This is the hard part of successful short-selling. Each trader has her own strategy for picking short-sale candidates. News about companies, economic news and stock-chart indicators can be used to find stocks a trader believe will go down in value.

Step 3

Place a short-sale order using the broker's stock-trading screen. Select Sell Short or Sell to Open as the type of trade. When the trade is entered, the broker's system will check to see if the shares are available to borrow. If shares are available, the trade will be filled. At that point you have borrowed shares of stock and sold them short. The proceeds from the sale will be restricted cash in your brokerage account until the shares are repurchased and the borrowed shares returned.

Step 4

Monitor the share price of your short stocks. When you are ready to buy back the shares and lock in your profit, enter a buy order using the brokerage account stock-trading screen. The order type will be Buy to Close.

                   

Tips & Warnings

  • Use stop-loss orders after your short-sell trade to close out the position if the stock goes up instead of down. A stop-loss is a pending order that is triggered if the share price reaches a certain level.
  • Stocks tend to move in an upward direction for long periods of time and downward moves tend to happen quickly. Selling short requires more monitoring than stocks purchased long -- regular stock investments.

Resources

References

About the Author

Jonathan Langsdorf has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Langsdorf has a bachelor's degree in mathematics from the U.S. Air Force Academy.

Advertisement