Short Selling Stocks

The idea of making money because of a stock price dropping, seems very foreign and down-right doesn't seem to make sense to most people.

Many stock investors feel it's un-ethical to sell short. They seem to believe we have to root for our companies to do well. Since most people in the markets have a natural tendency toward optimism, selling short is often viewed as being negative.

The fact is, there is absolutely nothing wrong with recognizing the reality of both the marketplace and economy.

Cycles are a fact of life. In the same way that it's rational to sell and avoid a large loss when a stock starts to decline, it's also reasonable to profit from that decline.

So what is short selling?

Selling stocks short is placing a sell order for shares you do NOT currently own, in the expectation that the share price will drop in the future.

For example, if you sell short company XYZ at $30, you simply borrow the shares from your stock broker for delivery to another buyer. If XYZ drops to $20, you then buy XYZ stock shares to replace those you owe your broker.

And in the process you make $10 a share.

So who says you cannot make money in a bear market?

So if you learn the rules for short selling stock and learn to use the proper tools, great profits can be yours!




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Short Selling Stock Don't's

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• Don't sell short because the P/E is high.

  There are countless stocks that their share price looked to be too high based on their P/E ratios, but the price went much higher in the months ahead.

  As a matter of fact, there are many stocks that turn out top be really big winners on the short side, even though they have low P/E's.

  So the lesson is: fundamental overvaluation is NOT the way to uncover a short sale even though it is the most common method of stock market players.

• Don't sell short because the stock price has advanced too far.

  If you like Russian Roulette, this is your kind of game. Stocks that go high, can indeed continue to go higher. Use your technical analysis tools to analyze the situation first.

• Don't sell a Sucker Short; a stock that everyone agrees must fall.

  These are a combination of a big run in share price, a high P/E and lots of media attention. In addition, it has a very large short interest (the number of shares of a stock that are currently sold short).

  Theses "too-obvious" stocks often have a short interest of five or more times the average daily trading volume. When a stock starts to climb with this high short interest, short sellers scramble over each other to buy back the stock to cover their shorts, which in turn pushes the share price even higher!

• Don't sell a stock that trades thinly.

  This means a stock that has little trading volume each day, like a few hundred shares. When you cover your short, your buying will cause the price to rise, and it doesn't take much buying to panic the other shorts, causing a short squeeze, thus driving the price higher.

• Don't sell short a stock in a strong Industry Group

  If overall, most of the stocks in the Industry Group it is in are all strong, be very mindful and cautious before selling short.

• Don't sell short without first protecting yourself with a stop loss order.

Click here for Short Selling Stock Do's

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Recommended Short Selling Stocks tools and resources.

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