Investment Strategies - Short Selling Strategies

Short selling involves purchasing borrowed shares, selling them and, ideally, returning to the lender the shares which experienced a decrease in price. The investor profits by buying high and selling low, as the investor has a bearish outlook on the company's prospects. In accordance with SEC and exchange rules, stock may be sold short only on a plus tick or zero-plus tick. A plus tick is a price higher than the last different price. The rules are designed to prevent short sellers from feeding orders into a declining market to manipulate a stock's price downward. The maximum gain on a short sale is the difference between the price at which the sale is initiated and zero minus any commissions. The maximum loss is potentially unlimited if the price of the stock rises. The mechanics of a short sale are as follows:

  • The investor opens a margin account.
  • Based upon her research and negative outlook for the company, she initiates the short sale of a round lot of the company's shares at the current market price of $15 ($1,500).
  • The client borrows the shares. Margin accounts allow the broker to lend shares. Large, well-known companies are more likely to have stock available to be sold short.
  • The investor sells the shares, depositing the proceeds in an escrow account.
  • The client covers her short position - with the share price down to $5, the client has the broker buy a round lot of shares for $500.00. The client collects $1,500 and clears $1,000.
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RELATED TERMS
  1. Short Sale

    A market transaction in which an investor sells borrowed securities ...
  2. Buy To Cover

    A buy order made on a stock or other listed security that closes ...
  3. Short Covering

    Buying back borrowed securities in order to close an open short ...
  4. Short-Sale Rule

    A Securities and Exchange Commission (SEC) trading regulation ...
  5. Minus Tick

    Designates a trade that occurs at a lower price than the immediately ...
  6. Short Selling

    Short selling is the sale of a security that is not owned by ...
RELATED FAQS
  1. What happens when the lender of the borrowed shares in a short sale transaction wants ...

    In a short sale transaction, shares are borrowed from the lender by the short seller and sold in the market. The lender of ... Read Answer >>
  2. How long can a trader keep a short position?

    Learn whether there are any limitations on how long may an investor hold a short position, and explore the costs associated ... Read Answer >>
  3. How is it possible to trade on a stock you don't own, as is done in short selling?

    Understand how the process of short selling allows a person to sell a stock he or she doesn't technically own by borrowing ... Read Answer >>
  4. What are the minimum margin requirements for a short sale account?

    In a short sale transaction, the investor borrows shares and sells them on the market in the hope that the share price will ... Read Answer >>
  5. When short selling a stock, how long does a short seller have before covering?

    There are no general rules regarding how long a short sale can last before being closed out. A short sale is a transaction ... Read Answer >>
  6. Why do you need a margin account to short sell stocks?

    The reason that margin accounts and only margin accounts can be used to short sell stocks has to do with Regulation T, a ... Read Answer >>
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