A short sale is a unique approach to stock trading where you actually sell shares of stock that you do not currently own. This offers you a chance to earn investment gains when you accurately predict that the share price of a particular stock will decline over time.
When you execute a short sale stock trade, you essentially borrow shares of stock that you do not own to complete the sale. If you manage your investments through a brokerage, you typically borrow the shares of stock from that brokerage. When you sell, your shares are purchased by another buyer in the marketplace and you earn the revenue from the sale of the borrowed stock. The money goes into your account.
At some point, you have to repay the shares that you borrowed by buying back shares in the open market to return to your brokerage. When you complete your purchase transaction, it is called covering the sale. Once you buy to cover, the complete short sale trade process is completed. Your net profit on the short sale is the difference between the price at which shorted, or sold shares, and the price at which you bought them back.
Your final profit on the short sale also includes consideration of fees that you pay for borrowing shares to sell. Similar to buying stock on margin, you must pay borrowing fees to your broker for loaning your shares for the short sale. This usually includes interest on the value of the stock. You may also have to pay back and dividends paid on the stock after your short sale.
You can lose money on a short sale just as you can on a regular stock purchase and sale. In fact, with the borrowing fees, your losses can be even greater. If the share price goes up after you short the stock, you must either hold it until the price drops or cover at a loss. For instance, if you short a stock at $10 and the price rises to $12, you would have a loss of $2 per share when you cover. Exiting before losses become steep is critical to success.
author Neil Kokemuller
Short Sale Stock Trades
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