Posted by stocker on December 22, 2009 in Stocks For Dummies | Short Link

You have heard people use the phrase “short stocks” and you have no idea what that means. If this sounds like you, then it is probably best to steer clear of this type of “investing” as you can lose quite a bit of money doing it. Of course you can make money too but there is more risk involved than the simple buying and selling of stocks.

When you short a stock you borrow the shares from your broker. You then sell those shares and pocket the money. For this, your broker will charge you interest and maybe some other fees. It is presumed you do this because you feel a stock is overpriced (overvalued) and you think it is going to go down.

At a later date, you will hopefully be able to buy the shares back (that you borrowed and sold) at a lower price. That way you can give the shares back to your broker but you will have paid less for them and profitied from the difference.

You need a margin account to be able to do this and you need to have an ample amount of money and history with your broker. This is because you can lose a lot of money doing this and your brokerage has to have some assurance you can pay.

Unlike regular stock investing where you can only lose what you put in, with stock shorting there is no limit to what you can lose. If you borrow and sell a stock at $100 a share (thinking it will go down) and it continues to go up to $200, you will have lost $100 per share. If it goes up to $300 you will have lost $200 per share.

At some point you will be forced to sell because your broker will make you based on the amount of money you have in your account. This is why you just can’t always wait it out and hope a stock goes back down again. If the stock you short goes up enough to bring your account to zero, your broker will do a margin call and you will be forced to buy the stock back at the higher price. This is why shorting stocks is not something any beginner should attempt to do.

The stock market for dummies is not a place where you should take a lot of risk. Many people have abused the shorting process and gotten in a lot of trouble. If you are looking into buying stocks for the first time, it is okay to understand what short sells are but not a good idea to try it until you have more experience.

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