Modern financial systems have made it easier for investors worldwide to invest in stock and make money.
In today’s world, assuming that an investor earns money when the price of a stock rises and waits for it to happen is wrong, as there are so many more ways to earn money with stocks.
This is where high-risk and high-return techniques such as short selling come into play. Herein, the investor bets against the stock, hoping that the price of a particular stock does not rise but instead hopes for it to decline.
The methodology behind shorting goes against the traditional approach of ‘going long.’
Recently, Gamestop became the first meme stock to be shorted as it gained traction in online forums and social media, and people started shorting the stock as a joke. However, it turned out to be a large-scale investing maneuver based on herd thinking and social media discussions. You can check out various blogs by reputed websites to gain more information about the whole event.
While it was the first Meme stock, it was not the first stock to be shorted, as there have been many before, and even after Gamestop, investors started to short stocks of declining companies such as Motorola, AMC entertainment, and much more.
If you do not know much about shorting a stock, here are some things you must know:
1. What is short selling?
Herein, an investor or a trader will not buy the stocks outright but would rather deal with the stock option. They will borrow stock options or even stock in some rare cases from a brokerage and sell them, hoping the price of the specific stock will fall.
Once the stock price falls, the trader will buy back the share at a lower price and earn the difference after paying the commission and other fees.
For instance, you borrow ten shares of Gamestop and sell them to the stock market for ten dollars a share. As soon as the stock price falls to five dollars, you could buy back the shares for half the price and return them to the broker. This leaves you with fifty dollars of gross income from the shorted stock, excluding the deduction for the commission, brokerage, taxes, and other such things.
2. How to short a stock?
Shorting a stock is not as easy as it sounds, as you are against the norms of the market and betting against the stock. To gainfurther understanding, you must follow various blogs and forums by reputed investing websites.
- To begin with, you would need a margin account which you can use to borrow shares. However, borrowing a stock is not free of cost as you will have to pay a certain fee depending upon the brokerage firm you are choosing.
- Furthermore, you need to have some capital in hand, as you need some collateral, either in the form of cash or stock equity for the margin account.
- You must have at least fifty percent of the short stock’s positional value as collateral in the account to begin trading.
- There are no rules about how long you can hold a short stock; you can keep the borrowed stock in your account for as long as you want. However, the more time you retain, the more interest you will accumulate.
- After you have the desired number of short stocks in the account, you must watch the market to determine the right time to sell.
- As the stock prices fall, you can close the short by executing a final buy order for the borrowed shares at a lower price and return them to the brokerage you procured the stocks from.
- When you return them to the brokerage, you will have to pay the fees and interest accumulated over time to maintain the short position.
Shorting a stock is not easy, and many new investors often follow the discussion on social media, which could lead to a loss. So, if you plan to short a stock, you must be prepared to take the high risk and clearly understand the market.