A Beginners Guide to Shorting Stocks

Experienced traders take advantage of stock market fluctuations by short stocking,

10:00 18 October 2019

But what is short stocking, and how can a trader make money from falling stock prices? 

What is Short Stocking:

Short stocking means purchasing and selling shares in the hopes that they will lose value. 

Traders who short stock are banking on the stock prices falling. When a trader “goes long” they buy stock with the expectation that the price will increase, and they can profit by selling their stock for a higher price than they bought it for. Short stocking in the opposite, traders sell stocks for the higher price, and then buy it back when the price drops, the difference between the price they sold it for and what they bought it back for is their profit. For example, if you sell 100 shares worth $1000 for that price, and buy them back for $800 when the price dropped, you’ve made a profit of $200. 

Short selling is not without its risks and it requires traders to have a margin account, which means that they can borrow from their broker. Furthermore, if the traders predictions are wrong and the stock goes up, there’s no limit to the amount of money they will lose,as the stock price can rise exponentially. On the other hand, when traders go long on stock, the only money they stand to lose is the money they spent on the shares in the first place. Short selling means that regardless of the market climate, traders can are proficient at both types of selling can profit in any situation, but only experienced traders should attempt to do so. In here, you will know how to Short a Stock (7 Steps) – Using TD Ameritrade as an Example.

How to Short Stock in 7 Steps:

Getting ready to short stock doesn't have to be a complicated process, here’s seven steps to get started:

1. Enable Your Account for Margin Trading
   
   

If you have a broker account, you will need to enable the margin trading feature if your account is not already a margin account. The broker will send documentation and questions, which need to be signed to show them that you understand the risks associated with short selling.

2. Enter Your Order to Sell Short
   
   

After the first step is complete you can input an order to short sell stocks, make sure to specify that this stock is intended for short selling.

3. Deposit the Account Minimum
   
   

The broker needs to protect themselves if your short stocking endeavours don’t work out, for this reason, traders must deposit the minimum amount of money set by the broker to their account before they can start short stocking. 

4. Stocks That Can’t Be Traded 
   
   

Not all types of stocks can be shorted, although it depends on the broker your with. Some brokers will not short penny stocks. This is because penny stocks, also known as OTC stocks or nano-cap stocks, are common shares of small public companies. Penny stock shares initially cost very little per share, but they eventually become expensive. 

5. The waiting period 
   
   

Once the account has been funded with the minimum amount of funds, you still have to wait three business days before you can begin short selling. During the waiting period, the broker may ask for more information from you while they’re reviewing your account to make sure you’re qualified to short sell. 

6. Reserving Shares To Short
   
   

As different brokers have different rules, not all of them allow traders do reserve shares to be shirted later. Traders with brokers who do not facilitate this need to manually check for available shares to short and issue orders. If an order is put it, but there are no shares available to short, then it won’t go through.

7. Short Selling Fees
   
   

The average rate of commission is approximately 7% per trade, although the exact rate differs between brokers. 

 

Short Selling Tips

Here’s some advice on short stocking and how to make the most of these trades: 

Timing

The right timing is important for all deals and trades on the stock market, but is especially important for short selling stocks. Moving at the wrong time could cost potential profits or incur a loss. Short sellers need to keep an eye on the market’s candlestick patterns as they would if they were going long to spot trends so they can capitalise on them. 

Practice makes perfect 

Traders should take advantage of stock trading tools until their comfortable short selling for real. StockstoTrade is an example of this as they offer realistic paper trading services so traders can practice trading without putting real money on the table. 

Traders can also join Profit.ly which is a stock market social media network. You can talk to other traders and seek. Users can discuss their trading strategies and outcomes, which can help new short stockers learn the ropes. 

Exercise caution

All trading comes with risks, but margin trading and shorting come with larger risks as there’s more to lose. This means that traders need to be fully confident before placing their order with their broker. 

A lot of traders are caught out when the price rises after they short a stock, and hope the price will crash back down soon. If the stock keeps rising the trader will continue to lose money. Sometimes it’s best for traders to cut their losses as soon as the price changes direction. 

Short Stocking with Options

A safer way to short stock is to stock with options. This method of short stocking is called placing a put option. “Put” means that you’re betting that the stock prices will fall, whereas a call option means that you’re anticipating that it will increase.

In this form of trading, a trader can exercise a trade on or before the contract expires. Here’s an example; if a trader has a put option on 200 shares worth $100, and the price drops to $80, they can exercise the put option and profit. However, if the stock price increases, the trader can opt out. Although they may lose money, they won’t lose as much as they would traditionally short selling.