How You Can Make Great Money During Falling Markets
Stocks on the stock market move in two directions: up and down.
When a stock’s price increases, sellers make money by selling at the higher price. That’s called buying and selling stock.
However, there’s another way to trade: short selling.
If you know how to short a stock, you expand the ways in which you can make potentially money through day trading.
It might sound complicated, but once you know how to short a stock with online brokers such as TD Ameritrade (which I’ve used in the past), it becomes second nature.
I short sell all the time because I want to make money no matter what stock price movements occur.
You can potentially do the same by learning how to take a short position.
What Is Short Selling?
Before I explain short selling, let’s do a brief refresher course on investing in the stock market …
A long position is the opposite of a short position.
When you go long on a stock, you buy shares at a particular price point because you believe the stock price will increase. If the price moves in the direction you anticipated, you can sell your shares in that stock at the higher price point and make a profit.
A short position is the exact opposite.
Short selling a stock means you’re betting the stock price will decrease over a specific period of time.
Learning how to short sell a stock takes practice, but it’s not as difficult (or as risky) as many people believe.
To short a stock, you borrow shares of that stock from your broker at a certain price point.
For example: Let’s say you think stock ABC will drop in price from its current price of $10. You might place a short sale order with your broker for 1,000 shares of ABC. The broker will then attempt to allocate those shares for your account and sell them.
Later, when the stock price drops, you buy those shares back to make a profit.
Let’s look at another example:
You believe that stock XYZ will drop in price in the future. It’s currently trading at $20 per share, so you issue a short sale order through your broker to sell 100 shares of XYZ.
The broker locates the necessary shares and sells them, putting $2,000 in your trading account. But remember, you borrowed those shares.
Later, you buy back the shares at a price point of $10, meaning that you only have to spend $1,000 of the $2,000 you pocketed. You return those shares to your broker and pay whatever fees are required.
That’s a simplistic view, but it’s the basic gist of how to short a stock.
Should You Try Short Selling?
Short selling isn’t for everyone, but it’s how some traders make great money during falling markets.
If you know you can potentially profit from the stock market even when you expect a stock price to crash, you can often continue trading regardless of the market climate.
How to Short Stocks
You’ll need a margin account to short stocks, which means that you’re able to borrow shares in a stock from your broker.
Margin trading is something I generally frown upon, but it’s useful when you want to short a stock.
Margin simply means that you’re buying or selling shares in a stock that you don’t own. That’s why many speculators are drawn to short selling.
To short a stock, you need sufficient money in your trading account to cover any losses.
You have to know your risk tolerance — backward and forward — and understand that the stock could go in the opposite direction.
How to Short a Stock With Options
Many people consider shorting a stock with options as the best possible move. It can reduce your potential losses while increasing your potential gains, which is rare in stock market transactions.
Shorting a stock with options is called placing a put option.
The word “put” simply means that you’re betting the stock price will decrease.
A call option, on the other hand, relies on the stock price’s increase.
Options trading gives you the right to exercise a trade on or before the contract’s expiration.
For example, if you have a put option on 100 shares of stock valued at $50, and the price drops to $40, you can exercise your put option and make money.
However, it’s called options trading because you have a choice.
If the stock price movement doesn’t go your way, you can opt to not complete the contract. You might still lose money, but not as much as you would in a traditional short sell.
Hang tight for tomorrow. I’ll go over my seven steps on how to short a stock. Cut and dry, no guessing. Just for you.
I’ve also thrown in a few tips if you decide you want to take on the stock shorting challenge.
— Tim Sykes
Editor, Penny Stock Millionaires