|Stocks To Short?
How Do You Short A
In their NY Times bestselling book
The Motley Fool
Investment Guide, David and Tom Gardner tell us that "when you short
stocks, you profit not when they rise, but when they fall; it's a neat idea
that not everyone realizes is even possible." The boys go on to detail exactly
how one goes about shorting a stock. Below is a recap of what it takes to
short a stock.
When you buy a stock, you try and buy at a low price, and then sell
at a higher price later. You do just the opposite with a short sale. When
shorting, you sell a stock first and then buy it back later. You might ask,
how can you sell something before you buy it? Great question :) When you
short a stock, your brokerage house does you a favor and lets you borrow
someone else's shares. (For this favor, they charge you interest on the money
it costs to get those shares ;) And, because the broker let's you borrow
the shares, this allows you to sell them first. It also means that you have
to return these shares at some point. Lets' look at an example where you
think Lame Duck Corp. (Nasdaq: QUACK) is going to fall in price:
- Call your broker and say you'd like to short 100 shares of QUACK.
- Broker sells the shares for you at $20 a share.
You are now "short" 100 shares of QUACK at $20. As time goes by, the stock
will most likely be higher or lower than $20. Hopefully for you, lower. Supposing
the stock falls to $10, you'd buy the shares back at the lower price of $10
and make a $10 profit because the stock fell in price.
Selling stock short just takes the "Buy-Sell" paradigm and flips it inside
out. You are still buying and selling QUACK, just in reverse order, hoping
for the "reverse" effect. You want the stock to go down.Tom and Dave also
give the reader some advice on what to look for in a short position.
1. Short stocks with a Fool Ratio (PEG)
of 1.4 or higher.
2. Short "closed" situations, not "open" ones. -
This just means that you want to avoid shorting
stocks that have unlimited business potential and look to short those that
are not in terribly strong growth businesses and that don't have very compelling
3. Short stocks with low short interest; avoid those with high short interest
- You can find the short interest of your stock
on a monthly basis in the Wall Street Journal or Investor's Business Daily.
High short positions mean that a lot of people are shorting the stock and
that it could move up powerfully if everyone was forced to "return" those
borrowed shares. At some point the owner will want them back and that usually
happens when the price moves higher.
Brokerage houses may have different rules about shorting stocks and we encourage
you to learn your broker's rules and regulations before shorting anything.
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