In my last post Stock Trading for Beginners we went over what stock is, how to buy stock, what does it mean to be long. We also talked about how you can make money when a stock goes up.
But what about when a stock goes down? Can you still make money in a declining market?
Shorting Stocks – Make Money When Stocks Go Down
Shorting is the opposite of buying a stock. When you buy a stock, you are hoping to sell it later at a higher price. Well shorting is just doing the same thing in reverse. You SELL first, hoping to buy it back later at a lower price.
You sell to get into the trade, and buy to exit the trade. Below is a screen shot of my tastyworks account, showing how to short a stock, using Tesla (TSLA) as an example. I didn’t actually place this trade, and I am not saying that TSLA is going up or down, I’m just using this to show what it looks like.
A lot of people stumble on that, how can you sell something that you don’t own? This is where your broker comes in. When you want to short a stock, you place a SELL TO OPEN trade with your broker. Your broker then gives you a credit equal to the price of the stock.
You can see above that if I wanted to short sell TSLA, it was trading at $304.19 a share. I would place an order to SELL, in this case 100 shares, of TSLA. I don’t have any shares, and my broker sees this, so automatically puts this trade in as a short sell.
My broker, tastyworks, charges a low commission of $5.00, plus a fee of $0.49 for this transaction, and deducts it from the sale. I received would receive a credit of $30,407.51, after the commission and fees are deducted. This is actually the most money I can make on this trade, and I will only make that total amount, if the stock falls to $0.00.
You don’t have any stock, you just have money from the trade you just made. You promise to buy the stock at a later time (hopefully at a lower price). To exit this trade you will place a BUY TO CLOSE trade through your broker to buy back the stock that you were short. This transaction will be a debit. Money is taken from your account and the stock is released by the broker.
So Let’s say that TSLA slides a bit down to say $250 a share. I would buy to close, so I would pay 100 X $250 = $25,000, and since tastyworks charges zero commission to close, I wouldn’t be charged another $5.00, but I would have to pay the $0.49 fee, so total would be $25,000.49 to exit.
My profit in this scenario would be the amount I received when I opened the trade ($30,407.51) less the amount I paid to close the trade ($25,000.49). My total profit would be $5,407.02.
SELL HIGH – BUY LOW = TOTAL PROFIT
$30,407.51 – $25,000.49 = $5,407.02
Short selling stocks requires your broker to loan you stocks to sell in the market, and you promise to buy them back. Hopefully you buy them for a lower price than you sold them, and you get to keep the difference. When you are shorting stocks you still are buying low and selling high, but just not in that order. You SELL high, BUY low, and keep the difference. The only thing that changed was the timing of it.
But what happens if the stock price goes up? Well, then you have to buy the stock at a higher price than what you paid, and you lose. In fact, you can lose A LOT of money, because there is no limit to how high a stock can go. This is why I don’t short stocks. But don’t worry, using options can limit your risk SUBSTANTIALLY so you can still make big money as stocks go down, but at the same time, covering your ASSets. (Funny, huh? No? OK.)
There have been more than a few stories about short sellers getting wiped out short selling a stock that suddenly rockets upward. You hear more about people losing everything shorting stocks than you do about people making it big being long stocks.
PROS of Shorting Selling Stock
If you can understand how to short stock, you can understand how you can make money not only when a stock goes up, but when it also goes down.
- Short selling stock allows traders to make money even when the market goes down.
- You don’t need to own the stock to short sell it.
CONS Of Short Selling Stock
- When you short sell a stock, your reward is limited to the credit you receive when you open the trade, because a stock can only go to $0.00
- Your risk is unlimited to the upside, there is no limit to how high a stock can go, and it can be real expensive to get out of a trade.