How dose Shorting work? Short selling stock.

Question

Can you please explain to me how does short selling stock makes you profits. I know that you borrow the stock when you price is going down and buy when it has bottomed out. I just don't know how do you profit off this. Please explain.

Thanks for taking your time to read and post! :)

Answer 1

Shorting involves selling stock you do not own.

Example:

Company A has a stock price of $10 per stock. You do not own any stock in company A. You sell 100 stock of company A (stock you do not own) for $10 each. Your brokerage will buy/sell the stock on your behalf (requires margin account) and will charge you interest on the money for the transaction.

A "short" makes a profit if the stock price goes down. In the above example, the "short" owes his brokerage 100 stock of company A (plus interest and fees). The "short" has $1000 in his hand though (sold 100 stock he did not own at 10 dollars each). If company A's stock drops to $5 a share, the "short" can buy 100 stock of the stock for $500 and repay his brokerage. The remaining $500 (minus fees/interest) will be his profit.

On the other hand, if the price of the stock for Company A goes up to $20, the "short" has to spend $2000 to buy the stock and makes a $1000 loss (plus interest/fees).

The above example is a basic example of shorting.  

Answer 2

How does anyone make money in the stock market?  Buy low, sell high, right?

Most people buy first, hope the price goes up, and then sell.  This is called having a long position.

When you short, you basically just reverse the order of that.  You borrow stock from your broker to sell it, hope the price goes down, and then buy.

You're still hoping to buy low, sell high, but you just do it backwards.  Your profit is calculated the same was as if you were long:

(selling price - buying price) * # of shares

Answer 3

There can be two types of short selling - though selling stocks you do not own is the prevailing practice. But a safer way to make money is in shorting stocks you own.

Suppose you own 100 shares of a company and the stock price for whatever reason is heading down. You sell 50 shares at the prevailing price. If the stock price keeps going down, you buy it back at a lower price - and the difference will be your profit.

What if the price goes up after you sell? Well, you have not 'lost' anything - other than the opportunity to sell at a higher price. But since you will still have 50 shares left, you can sell those at the higher price.

If you own one of the cyclical (such as commodity) stocks, then this is a great way to make money without much risk.

While short selling stocks you do not own can make you far greater profits, it comes with much greater risk of making huge losses.