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Article #120: The Basics Of Short Selling Stocks

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'Shorting' or short selling refers to the help to predict a fall in price of
selling of a contract, a bond or stock or stocks: -
a commodity that is not directly owned by - Market indexes coming near the prior
the seller. When practicing short resistance levels.
selling, a seller is committed to - Market trend showing technically
purchase the stock or commodity overbought levels.
previously sold. - Restlessness before the announcement of
Short selling stocks means to take the a state's government.
stock from a broker on loan and sell it - Market vulnerability during scandals.
off to someone else. This is done so that Large volume selling of stocks often
the seller buys back the stock, when the result in short-term high profits.
price falls. The shares are returned to However, there are certain guidelines to
the broker from whom they were initially be followed for successful short selling.
borrowed. The shorting profit or the They are:
difference in price goes to the seller. - All stocks are not 'short' able.
Short selling of stocks is a technique Generally, brokers inform a seller
used by investors to capitalize on a whether a stock can be used for short
probable decline in the stock price. selling or not.
To understand this better, let us - Sellers must open a margin account for
consider a company, say, ABC whose shares short selling. This depends on the
currently sell at $12 each. A short minimum balances and cash reserves.
seller borrows 50 shares of ABC and then Sellers are required to sign a contract
sells those shares to someone else at $12 agreement with the brokers to open a
per share, for a total of $600. Now, if margin account. This agreement clearly
in future the price of shares of ABC states that a seller will follow the
falls to $10 per share, this short seller rules and regulations stated by the
would then buy back those 50 shares at broker.
$500 ($10 multiplied by 50 shares), send -Target bad-performance, overpriced
back the shares to the original owner companies, since the probability of a
broker and make a profit of $100. fall in the share price involves lesser
Short selling is risky, if the price per risk.
share goes up instead of declining, as - Traders and short sellers should use
expected. Suppose the price per share of stop orders to protect their capital from
ABC goes up to $15 per share, then the loss. Generally, brokers prevent a seller
short seller will have to cash in the from suffering loss more than the
previously sold 50 shares at $750, return principal. They may either compel the
the shares to the original owner and seller to quit the transaction or they
incur a loss of $150. may deposit funds to increase the
Shorting is a transaction done on margin. seller's capital.
Most brokers do not agree to short The short selling of stocks involves a
selling stocks below $5. This enables the lot of discipline. Sellers need to be
investors and short sellers to indulge in proactive, alert and disciplined when
the high-risk trading of stocks. shorting stocks.
Some of the following market situations






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