When to Short Stocks
An often effective means of profiting from a falling stock is to short it. Shorting is when a trader sells a stock that he does not own. Essentially he borrows the stock from his stock broker and has to have money in a trading account to cover potential losses. In addition the trader who shorts a stock pays interest on the loan of the stock for the duration of the short. When to short stocks is when you expect the stock to fall in price. When to short stocks is when the trader seeks to leverage his or her trading capital. Shorting stocks is a little like buying options in that the trader enters into a position with a lower capital investment than when he buys a stock and can often gain multiples of the cost of engaging in a short. Unlike options trading, the trader is obligated to buy back the stock at some point in time. Although he can stay in the short position indefinitely, there comes a time when the cost of the position becomes prohibitive. What is a realistic profit when trading stocks by this route? Although profit can be substantial in a well-placed trade, traders are well advised to do diligent technical analysis of the market in order to enter and exit at trade in the most profitable manner.
The Problems Related to Borrowing Stock
To a degree, when to short stocks is not when you expect there to be a stock split or a dividend payment. Because you have just borrowed the stock you will need to return twice the number of shares after a split and give dividend payments to the brokerage whose stock it still is. And, if the stock price rises greatly, and you do not have sufficient capital in your trading account you may be required to replenish your account or the brokerage may simply sell your shares and expect you to come up with the rest of the cash. Many times a brokerage retains the right to take the stock back (call it away) as when many traders are shorting a stock and the brokerage house only has so many shares to offer.