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Stock Trading Profits From Selling Stocks Short

Sep 16, 2008
Selling "short" on a stock is a risky proposition, in which you essentially bet that you can sell stock that you don't own yet, but which has been promised to you, at a price higher than you'll be able to purchase it for, in order to make a profit.

To a stock-market neophyte, this may sound ridiculous; how can one sell something one does not yet own? However, short-selling, while an advanced concept, is actually quite simple to understand, once it has been put in plain words.

What happens is that your stockbroker has stock available, whether from his own personal investments, or another customer, which he lends to you. The shares are sold in your name, and the proceeds are put into your account - but then you must purchase the same number of shares of the same stock, and return them to the broker, at a slightly higher cost than that at which he lent them to you.

Essentially, it's loan of stock which must be repaid, with interest - whether you actually make a profit or not. If you are able to repurchase the shares at a lower price than that at which they were sold, you win your bet; but if the price rises instead, you lose. Usually, a "short" can be held for as long as is necessary to make a profit; however, if your broker needs the stock returned suddenly, you can be forced to buy back the shares that you sold, regardless of the price. If your broker overextends himself - which is unfortunately easy to do - you may find that he will put pressure on you to make the purchase before you're ready.

Clearly, while the opportunity to profit in short stock trading is attractive, there are several risk factors of which you should be aware.

First, stock prices, in general, typically tend to go up - not down. You are taking the chance that a particular stock will "buck" this trend. If it doesn't, you'll show a loss, not a profit.

Second, you need to remain aware at all times that you are borrowing stock - and, therefore, money - and that you can, in fact, lose more than you put in on the deal. Many people overspend with their credit cards; the same is unfortunately true of short-sell stock deals: convinced that they'll be able to make a profit and pay off the loan, people tend to oversell - and occasionally are unable to make good on the debt.

Third, if a particular stock is being short-sold by a number of investors, and they all sell their shares at once, it can force the price to go higher than expected, making the repurchase more expensive for everyone, and causing you a loss. There is no way to know how many people are planning to sell a particular stock short.

However, if one is aware of the risks, and is careful not to gamble with more than one can afford to lose, selling short can be a profitable experience.

If your tolerance for risk is broad enough to encompass the chances involved with selling short, it can be an excellent way to to boost your stock trading profits - if you have the know-how. However, it is an advanced concept, and if you are new to investing, it may be better to leave short-sell trades alone until you have more stock trading experience.
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