Short Selling, Part Two
Last time in this blog, we introduced the concept of short selling, something that we’re going to be discussing over the next few entries. It’s a pretty simple technique that quite a lot of people are involved in, but like any aspect of trading, it involves its own unique set of risks and opportunities. As such, it warrants a closer look than you might have given it in the past.
What Exactly Is Short Selling?
Like we said last time, it’s a way to profit off of a bear market. You invest in a stock, but you profit when the value of the stock decreases rather than increases. Here’s how it works.
When you short sell a stock, you’re essentially selling a stock that you do not own. If that sounds weird to you, well… that’s because it’s a weird situation, and hard for many to understand. When you short sell, your broker is entering an agreement with you that they’re paying you for the selling of a stock today and that you’ll actually buy that stock at a later date, in order to restore balance to the transaction.
One typically engages in short selling when they expect that the value of a stock is about to fall soon. Say that you short sell on a stock that is worth $1000. You do this and the broker gives you that $1000. Then, before the time period expires in which you have to actually buy the stock in question, the stock collapses and is worth only $500. You’ve just made $500 off the decline of a stock!
Of course, there are risks to be had here. For example, if the value of the stock rises, then you’re still obligated to make the purchase. You might well find yourself having to shell out significantly more than you sold for in the first place. Next time, we’re going to take a closer look at what goes on in a short sell transaction.
See you next week for part 3 of Short Selling.
Sean Rasmussen
The Bullhunters Guide
Universal Wealth Creation © 2004 - 2008
Tags: bear market, Investing, market, profits, Short Selling, Stock
