Shorting stocks isn’t always a smart move

Quick Notes

  • Shorting a stock means to borrow shares from an existing owner and then re-sell the shares at the current market price.

  • While there is the possibility for gains, there are also significant risks involved in shorting stocks

  • Experts recommend leaving shorting stocks for experienced investors

Shorting a stock may seem like easy money. However, this isn’t always the case. When shorting a stock, investors take on more risk. Essentially, they are at the will of the market and have to hope for the best.

If you’re new to trading, the best way to move forward with shorting stocks is to get all the facts before you make a big move. Understanding the ins and outs of shorting a stock could be knowledge worth thousands of dollars.

How to short a stock

Shorting a stock, also known as short selling, is a popular maneuver among speculators, gamblers, and even individual investors. To short a stock, an investor must first borrow shares of a company from an existing owner through their brokerage. Then, the investor would re-sell the shares they borrowed at the current market price.

Piqsels

As you can imagine, shorting stocks successfully requires a bit of market knowledge and finesse. Otherwise, an investor would borrow the stock at a price higher than the current market value and therefore lose money, sometimes lots of money.

For example, say you borrow 100 shares of Apple stock for $45 a share (yes, this is hypothetical) because you believe the iPhone 11 was going to tank, and their market value would be on the downturn. Your investment is now $4,500. In the instance Apple does tank, to say $22 per share, you can then resell your 100 shares of Apple stock at $2,200, netting a profit of $2,300.

Another scenario would be that Apple takes off after the iPhone 11, and shares reach $90 per share. Now, you’ve already borrowed the 100 shares for $4,500. To resell your 100 shares at the $90 per share rate, you’d pay $9,000. Essentially, this is a $4,500 loss.

Easy money, or big risk?

The risks are clear with shorting a stock. Therefore, investors should be wary.

“But if you have a short position, there’s no limit to how much money you can lose if the shares rise,” writes investor columnist Phillip Van Doorn. “If the share price increases soon after you place a short position, you could quickly ‘cover’ by buying back the shares and returning them to the investor you borrowed them from. If you’re lucky, you might not lose very much.”

If you’re unlucky, however, you may not have enough cash to cover how much you’ve lost. Forfeiting assets and retirement plans just for shorting a stock doesn’t seem to wise, now does it?

“But if you have a short position, there’s no limit to how much money you can lose if the shares rise,” writes investor columnist Phillip Van Doorn. “If the share price increases soon after you place a short position, you could quickly ‘cover’ by buying back the shares and returning them to the investor you borrowed them from. If you’re lucky, you might not lose very much.”

Overall, there’s plenty of money to be made by shorting stocks. However, it’s advised that only investors with a lot of experience – and capital to back up their mistakes – participate in this type of work.

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