The New Sell and Sell Short: How to Take Profits, Cut Losses, and Benefit from Price Declines, Expanded Second Edition

PART THREE

HOW TO SELL SHORT

Pssst! Want to hear a secret?

Here it is, but please keep very quiet: Stocks sometimes go down.

Yes, really! Everybody keeps buying them but sooner or later every stock price drops.

If living well is the best revenge, then one of the sweetest things you can do in the markets is to take something that hurts everybody—price drops—and turn that into a source of profits. Think of all those times you bought a stock and it cratered. Had you been on the opposite side of that trade, you’d be making money instead of losing on every downtick.

If you would like to profit from price declines, we need to talk about selling short.

Everybody understands how to make money from buying low and selling high, but many have no concept of how to profit from price drops. To make sure we are on the same page, let’s run through a basic explanation.

Suppose you look at IBM, trading at $90, and decide it is going to $99. You buy a hundred shares, hold, and sell when the stock reaches your profit target. You make $9 per share, for a total of $900 on 100 shares, minus commissions and fees. This is so simple, a child could understand it. But what if you look at IBM at $90 and conclude that it is overvalued and likely to drop to $80? How can you possibly profit from that?

A short-seller enters a trade by borrowing someone else’s shares and selling them in the market. Later on he buys back the same number of shares and returns them to his lender. This is possible because ...