Short Selling

[buhJipizpuh]

I'm trying to understand short selling and I read this article that supposedly give an easy explaination. But according to his words, he have to sell the book at a "higher" price to make a profit. Don't that contradict the notion of making money when the price get lower?

Don't the broker that lend the shares loose money when the price go down?

How long can an investor borrow the shares from the broker to sell short? 1 day? 1 week?

[bulfuddinlela]

Over the last few months, whenever I am asked at a social function what I do I respond “I trade stocks”, which usually prompts a “look” that ranges from pity to Schadenfreude (http://en.wikipedia.org/wiki/Schadenfreude). This is usually followed by something akin to them saying “things must be pretty tough, huh?” I of course respond that I am doing fine, because I can make money when the market moves down by……………
SHORTING…..!!!! (insert glazed look in conversationalist’s eyes).

My mother actually thinks that I am doing something illegal when I tell her I can make money if a stock goes down. Personally I’ve never had an issue with the concept of shorting, which is probably why I trade. But for others who don’t quite understand the concept I have developed a simple way to explain it. It goes like this…..

[Burndiura]

A share of stock is a standardized instrument just like a book or a DVD, meaning each share of IBM is the same, just like every copy of “Harry Potter and the Deathly Hallows” on the shelf at the local bookstore is the same.
So let’s say your best friend just bought a brand new copy of “Harry Potter” and the moment he brings it home you ask him to borrow it. Now that you have borrowed it from him, you owe him back one copy.

You then take the copy he loaned you and sell it. Maybe you sell it on Ebay, maybe at a garage sale, maybe to an individual, it doesn’t really matter. You get $25.00 for the book when you sell it. You still owe your friend one copy of Harry Potter, so you order a copy on-line from a discount book wholesaler. That copy only costs you $19.95.
The book arrives and you return it to your friend, keeping the difference between what you sold it for ($25.00), and what you bought it back for ($19.95). You have thus made money by selling something you did not own and then buying it back (and replacing it) for less that you sold it for.

[Buzaronel]

Most brokerage firms make it easy to sell short. You simply place an order to sell the stock, and the broker asks whether you are selling shares that you own or selling short. Once you place the order, the brokerage firm goes about borrowing shares for you to sell. It loans the shares to your account and executes the sell order.
You can't sell short unless the brokerage firm is able to borrow the shares. Sometimes, so many people have sold a stock short that there are no shares to borrow. If that's the case, you'll have to find another stock or another strategy this time.
Once the shares are sold, you wait until the security goes down in price, then you buy the shares in the market at a bargain. These purchased shares are then returned to the broker to pay the loan, and you keep the difference between where you sold and where you bought — less interest, of course.
The stock exchanges are in the business of helping companies raise money, so they have rules in place to help maintain an upward bias in the stock (http://www.dummies.com/how-to/content/the-art-of-short-selling.html#glossary-equity_market;_stock_market) market (http://www.dummies.com/how-to/content/the-art-of-short-selling.html#glossary-equity_market;_stock_market). That can work against the short seller. The key regulation is what's called the uptick rule, which means you can sell a stock short only when the last trade was a move up. You can't short a stock that's moving down.

[Calvinpync]

When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later, you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money. I did that this morning as one stock went up over 9 dollars a share yesterday. I want short this morning on them.

Most of the time, you can hold a short for as long as you want, although interest is charged on margin accounts, so keeping a short sale open for a long time will cost more However, you can be forced to cover if the lender wants the stock you borrowed back. Brokerages can't sell what they don't have, so yours will either have to come up with new shares to borrow, or you'll have to cover. This is known as being called away. It doesn't happen often, but is possible if many investors are short selling a particular security.

Because you don't own the stock you're short selling (you borrowed and then sold it), you must pay the lender of the stock any dividens or rights declared during the course of the loan. If the stock splits during the course of your short, you'll owe twice the number of shares at half the price.