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!!

SPY MONTHLY CHART LOOKING GRIM

The technicals are mounting in favor of the bears. Looking at the monthly chart for SPY, I noticed yet another double top… and more ominous, divergence with the RSI and volume.

What does the declining volume tell me? It tells me that month over month buyers are becoming harder and harder to find. What does the declining RSI tell me? It tells me that SPY is trying to come down from such overpriced conditions.

Of course, fundamentally, you have QE (quantitative easing) propping up the price. This is creating a condition, in my opinion, that will eventually trap new and novice investors. The newbies are probably buying up stocks, because they see there’s a rally. But the problem is, the rally is so old, and so high in price, that they are bound to get burned when this thing comes crashing down.

Do I think a recession is imminent? No. Do I think a big correction (15 to 20%) will happen? Yes! However, with that said, lowering rates and QE after QE is not necessarily a good thing. That could lead to recession type behavior eventually… it’s called DEBT!! The more debt companies get themselves in, the harder it will be for them to climb out if and when interest rates begin to tick back up.

I am overall a bullish investor, but right now I have a bearish sentiment. The technicals and fundamentals are pointing to a big correction in the works. But that’s ok! Because, after it does correct, I will sweep in and scoop up as much as possible for the next leg up. That’s investing 101 for a bull: buy low, sell high. Right now, it seems investors are buying high and selling high… that’s very dangerous!

Remember: ALWAYS DO YOUR OWN RESEARCH AND CONSULT A PROFESSIONAL IF YOU ARE UNSURE WHAT TO DO.