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Stocks 101: Short Selling For Starters

When I was a high school student, I tried my best to learn the stock market because I decided early that it was going to be my main concentration in college.

One thing that I learned is that the Stock Market has its own language and it is very difficult to understand.

In my Stocks 101 posts I will focus strictly on making the language as easy as possible to help the reader obtain as much information as possible.

If  you are trying to understand short selling, I am pretty sure you already understand the concept of buying a stock. When you buy a stock, you are buying a piece of the company, you own a tiny portion of the company(depending on how many shares you purchase).

Before I define short selling, I feel that it will be easier understood if I define going long on an investment first.

It is very simple.

Don’t be intimidated by all of the terms used in textbooks and crazy definitions that your professors use. Going long on an investment means that the investor believes the stock that they purchased will rise in the future. So when an investors short sells a stock they believe the price will decrease in the future.

This is where it gets a little confusing, just stay with me.

Short selling is the selling of a stock that the seller does not own. When you short sell a stock, your broker basically lends it to you. These shares are sold and credited into your account. Eventually you have to “close the short” .

The New York Stock Exchange

Closing the short simply means buying back the exact number of shares and returning them to your broker. If the price dropped you are in great shape. You buy back the stock at the lower price and you take the profits. BUT, if the stock happened to rise, you have to buy it back at the higher price and you LOSE.

If you are still confused, here is an example:

Say I own 10 shares of marks bakery at $30 per share. You have a gut feeling that the price of Marks Bakery is way over valued and is going to dip in the near future. You borrow the 10 shares from me and sell them at $30 dollars per share, pocketing $300 dollars.

As you so intelligently predicted, the price of Marks Bakery stock dropped to $10 per share. Now you contact your broker and buy 10 shares of Marks Bakery at the new price. This costs you $100. You return the 10 shares to me eventually, but what you did for yourself was make a $200 profit. Simple right?

The concept may seem simple to you now, but there is a lot of time and effort put into short selling. If the stock price went up, You owe me more money than you expected. There is a lot of risk in this game, but where there is risk there is reward.

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About breakinbadd
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4 Responses to Stocks 101: Short Selling For Starters

  1. Great explanation, I am uneasy about going short though, very hard to predict short term market movements, and do not want to have short positions open for a long time spread betting tips

  2. Tuan Michel says:

    Thanks for helping out, superb information.

  3. MCX Today says:

    yeah man u r right…

  4. gilgil2 says:

    Great explanation of shorting. It is probably easier to use a spread betting account, or CFDs (though I think the latter is illegal in USA) so depends on where you are. There is a good article on shorting shares for people without the clout of financial institutions at http://www.trading-deals.com/index.php/blog

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