5. Shorting Stocks

Intro to Shorting Stocks

Usually, shorting a stock goes like this: you identify an overvalued security and wish to take an opposite position. To do this, you don’t buy the stock outright, you borrow the stock from your broker and immediately sell it.

You eventually need to return the shares to your broker, but you anticipate the share price being much lower when it comes time to settle up (which is called covering your short). 

If the stock you borrowed declines 10%, you can buy the shares on the open market and return them to your broker. You’ve now made a 10% profit on the trade – the difference in the price you sold the borrowed shares for and what you paid when returning them to your broker.

Shorting stocks requires a margin account since you need your broker to lend you the shares in the first place. Borrowing shares from your broker involves the same stipulations as borrowing cash, including interest payments. 

(Note: You can also bet on a stock to decline by buying put options. A put option is an agreement to sell a particular security at a predetermined price on or before a specific date. Options don’t require a margin account, but they do involve leverage so be sure to understand how they work before attempting to short a stock in this fashion.) 

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