How Does Short Selling Work?

Short selling is a way to potentially make money in a bear market. When stocks go down, you can profit. Crazy concept huh? After all, as the saying goes, “buy low, sell high.” With short selling, the saying goes, “sell high, buy low.”

This is actually a strategy used by many, even in bull markets. There are always short selling opportunities. Do I short sell? Nope, never have. I do buy put options, which is kinda-sorta the same thing.

So what is short selling?

You borrow shares from your broker and sell them on the open market. Later on – if your analysis was correct and the share price drops – you buy the shares back at a cheaper price than you sold them for, and you keep the difference as profit.

Let’s say ABC is currently selling for $100 per share. You have done your research and proper analysis, and you think ABC is going down. So, you enter a “sell to open” order with your broker, for 100 shares. Your broker lends you those shares and they are automatically sold for $10,000 ($100 per share times 100 shares).

The $10,000 goes into your account, as that is what you sold them for. But DO NOT SPEND THIS MONEY, lol… the trade could go against you.

A week goes by and ABC is down $10 per share to $90. Woo hoo!! Fantastic analysis you did. You decide to close out your position by placing a “buy to close” order. The order is executed, and you just bought the shares back for $9,000 ($90 per share times 100 shares). The broker gets their 100 shares back, and you keep the difference of $1,000 ($10,000 you sold for minus the $9,000 you bought them back for).

Short selling was a bit confusing to me when I first learned of it. I thought, how in the world can you make money when a stock goes down. Well, if your broker is willing to lend you shares, that’s how. You do need a margin account to place short trades. And, of course, margin accounts can be very dangerous for a multitude of reasons.

If you are interested in short selling, contact your broker to find out what you need to do. Also, DO YOUR RESEARCH AND KNOW WHAT YOU ARE DOING FIRST!!