• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar

Wealth Pilgrim

No Money Worries. No Matter What.

Neal Frankle featured in
  • Home
  • Life Insurance
  • Investing
    • Build Strong Investment Building Blocks To Avoid Going Broke In Retirement
    • Systematic Mutual Fund and ETF Investing
    • Stock Market Investing Guide
    • Choosing the Right Investment Brokerage Guide
    • How Bonds Work Guide
    • How Banks Really Work Guide
    • Annuities – What You Need To Know Before You Invest
    • A Beginners Guide To Buying Individual Stocks
    • Create A Pool Of Great Mutual Funds and ETFs To Pick From To Secure Your Retirement
    • ETF and Index Fund Investment Guide
  • Earn More
  • Banking
  • Retirement Planning
    • Retirement Guide
  • Ask Neal a Question
  • Reviews
    • Upgrade Personal Loans Review
    • Lending Club Review
    • Prosper Review
    • Ally Invest TradeKing Review
    • CIT Bank Review
    • LegalZoom Review
    • Lexington Law Review
    • Airbnb Host Review
    • Should You Drive For Uber?
  • Tax
  • Courses
    • Raise Your Credit Score So You Can Buy a House – Free Video Course

What Is Short Selling In The Stock Market?

by Neal Frankle, CFP ®, The article represents the author's opinion. This post may contain affiliate links. Please read our disclosure for more info.

When you sell stocks you don’t own, you sell short. That’s all there is to it. You might ask how it’s possible to sell something you don’t own and why people do this. Good questions. Let’s tackle one question at a time.

How can you sell stocks you don’t own?

Easy…..you borrow them from a brokerage firm. All the brokerage firms do this. After you borrow the shares you sell them and stuff the cash in your pocket.  🙂

Of course the broker who lends you the securities charges you interest on the transaction. And at some point, you’ll have to replace that borrowed stock.

How do replace the stocks you borrowed and sold?

You’ll buy shares on the open market at some point of your choosing and hand them over to the kind broker who lent them to you.

Why do people go through this rigmarole?

People sell stock short because they think the stock price is going to drop like a bowling ball in a pool and they want to make some hay on it. Let’s consider an illustration. (We’ll keep it simple by ignoring the trading and interest costs of selling short for now and just focus on the main transaction.)

Assume you don’t own any XYZ shares but you think it’s about ready to head south big time. You put in a “sell short” stock order and sell 100 shares at $40 a share. $4000 is neatly deposited into your account. How sweet it is……

Keep in mind that at this point you “owe” the brokerage firm 100 shares of XYZ. You do not owe them $4000. This is critical to understanding the short sale my friend.

Assume that a few weeks go by and the stars of luck shine on your happy face. The stock drops to $25 per share. At that point, you buy 100 shares of XYZ at $25 per share at a total cost of $2500. The broker debits your account that $2500 to pay for the trade. So far so good.

The brokerage company keeps the 100 shares you bought because you owed them those shares. So everything is back the way it was.

But did you notice the magic? You keep $1500. It’s yours. That’s the profit you made as a result of XYZ stock dropping in price. Pretty nifty huh? That’s the beauty of selling short when things go well.

You Can Lose Money Also When You Sell Short

Of course, if the stock price rises you will get roughed up a little. Using the example above, look at what happens if the share price rises to $50 per share after you sold short at $40.

In that case, you’ll buy back 100 shares at $50 for a total cost of $5000. Since you sold the shares at $40 for a total of $4000 you will owe the brokerage firm $1000. That’s your loss as a result of buying at $50 and selling at $40.

Why You’d Have To Be Coo – Coo To Sell Short or Buy Short Funds

Unless you have a working crystal ball the chances of making money selling short are pretty low. That’s because the natural tendency of the market is to rise. When the market sells off, it often does so quickly and unexpectedly. I have never met anyone who has successfully sold short and made money on a consistent basis. It’s just too hard to time.  It’s far better to find a good solid investment strategy and stick to it.

Do you ever short stocks or buy funds that do? What has been your experience?

Tweet
Pin
Share

Reader Interactions

User Generated Content (UGC) Disclosure: Please note that the opinions of the commenters are not necessarily the opinions of this site.

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Are You Human? * Time limit is exhausted. Please reload CAPTCHA.

Primary Sidebar

Who is Neal Frankle

Neal Frankle

I'm a CERTIFIED FINANCIAL PLANNER™ Professional with more than 25 years of experience. I feel very blessed and hope to share my personal financial experience and professional wisdom with readers of WealthPilgrim.
Read More »

Stay Connected

Facebook Twitter YouTube RSS

More Categories

Career Development
College Funding
Credit Cards
Credit Score Fixes
Money and Marriage
Debt Relief
Estate Protection
Property Investment Loans
Small Business Strategies
Spend Less Money

Disclaimer

Wealth Pilgrim is not responsible for and does not endorse any advertising, products or resource available from advertisements on this website. Wealth Pilgrim receives compensation from Google for advertising space on this website, but does not control the advertising selection or content. Please do the appropriate research before participating in any third party offers. The information contained in WealthPilgrim.com is for general information or entertainment purposes only and does not constitute professional financial advice. Please contact an independent financial professional for advice regarding your specific situation. Wealth Pilgrim does not provide investment advisory services and is not a registered investment adviser. Neal may provide advisory services through Wealth Resources Group, a registered investment adviser. Wealth Pilgrim and Wealth Resources Group are affiliated companies. In accordance with FTC guidelines, we state that we have a financial relationship with some of the companies mentioned in this website. This may include receiving payments,access to free products and services for product and service reviews and giveaways. Any references to third party products, rates, or websites are subject to change without notice. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers.


About · Contact · Disclaimer & Privacy policy

Copyright © Wealth Pilgrim 2022 All Rights Reserved