The process of stocks short selling consists of the following: The investor borrows shares of the stock they are going to short from his broker. This step is accomplished using "cash on deposit" at brokerage firm that can be used as collateral. So when an investor borrows stock, they're promising to give back the stock at a future point in time. The stock you borrowed is then sold at the market, and the cash from that transaction is paid in your brokerage account. You (investor) then wait for a decline in price, if there is any, and after the price goes form 15$ to 10$, you close a position by buying back the shares. This is what is called covering a short position. The investor returns the borrowed shares back to their broker or lender.
EXAMPLE OF HOW IT WORKS:
Let's say that you believe that ABC Company Inc. stock is due to fall, you then calls your broker to sell short 1000 shares of the company. Also, let's assume that your trade is immediately executed, to sell short 1000 shares of Company Inc. at $30.00 per share. You will receive a cash inflow of $30,000 from this transaction.
EXAMPLE OF HOW IT WORKS:
Let's say that you believe that ABC Company Inc. stock is due to fall, you then calls your broker to sell short 1000 shares of the company. Also, let's assume that your trade is immediately executed, to sell short 1000 shares of Company Inc. at $30.00 per share. You will receive a cash inflow of $30,000 from this transaction.
In four weeks later, the price has indeed dropped, and you are able to buy back the shares (also known as covering a short position) for $20.00 per share. In this transaction, you will spend $20,000 to buy shares that you need to cover your position. Your profit on the trade will be $10,000 ($30,000 minus $20,000). If stocks had risen to $35.00 during the time position was opened, then he would have a loss of $5,000 (1000 shares x $5.00/share).
RISK OF SHORT SELLING STOCKS:
Short seller is still trying to do the same thing a regular investor is, and that is to buy low and sell high. But the short seller is trying to do this in reverse order. He is trying to first sell high and then buy low. The short sales strategy, which is the opposite of entering a long position, is a risky one for a several reasons. These include the potential for a margin call, and theoretically unlimited losses if stock price rise, since the price of a stock cannot fall below $0 per share, the upper limit for profit is the total value of the stock sold short.
OTHER IMPORTANT THINGS TO KNOW EVEN IF YOU DO NOT SHORT SELL STOCKS:
Short interest is a measure of the total share volume that is currently short the stock. When a person short sells, the order must be identified as a short sale and these statistics are kept for each stock by the exchange. Short interest can be a source of demand if buyers become enthusiastic for the stock and price rises prompting some short sellers to reduce risk by buying back stock to replace and closing the short position.
A high short interest ratio is considered bullish while a low ratio is considered bearish. A ratio of 2 is considered 2 days potential buying power. In some future posts, when I'll write more about investment strategies, and what does work and what don't, you will se that actually, low short interest ration is a bullish sign!!! But more about that later.
The short interest ratio is called a contrary opinion indicator because an increase in short selling is an indication of a strong potential demand element as short sellers are likely to close positions quickly if the market price proves them wrong.
Odd lot short sales has been considered a measure of uninformed investors and was used by investors to give evidence of market bottoms as late comers to the market were considered uninformed. Now it's not widely used.
Specialists short sales are also available as a data source for measuring short selling. This is considered the smart money. Often investors watch the ratio of specialists short sales to total number of short sales to give an indication if the smart money is bullish or bearish. A short sell can be used as part of a bullish strategy as so can skew the basis for interpreting the ratio.
That's all for today.
RISK OF SHORT SELLING STOCKS:
Short seller is still trying to do the same thing a regular investor is, and that is to buy low and sell high. But the short seller is trying to do this in reverse order. He is trying to first sell high and then buy low. The short sales strategy, which is the opposite of entering a long position, is a risky one for a several reasons. These include the potential for a margin call, and theoretically unlimited losses if stock price rise, since the price of a stock cannot fall below $0 per share, the upper limit for profit is the total value of the stock sold short.
OTHER IMPORTANT THINGS TO KNOW EVEN IF YOU DO NOT SHORT SELL STOCKS:
Short interest is a measure of the total share volume that is currently short the stock. When a person short sells, the order must be identified as a short sale and these statistics are kept for each stock by the exchange. Short interest can be a source of demand if buyers become enthusiastic for the stock and price rises prompting some short sellers to reduce risk by buying back stock to replace and closing the short position.
A high short interest ratio is considered bullish while a low ratio is considered bearish. A ratio of 2 is considered 2 days potential buying power. In some future posts, when I'll write more about investment strategies, and what does work and what don't, you will se that actually, low short interest ration is a bullish sign!!! But more about that later.
The short interest ratio is called a contrary opinion indicator because an increase in short selling is an indication of a strong potential demand element as short sellers are likely to close positions quickly if the market price proves them wrong.
Odd lot short sales has been considered a measure of uninformed investors and was used by investors to give evidence of market bottoms as late comers to the market were considered uninformed. Now it's not widely used.
Specialists short sales are also available as a data source for measuring short selling. This is considered the smart money. Often investors watch the ratio of specialists short sales to total number of short sales to give an indication if the smart money is bullish or bearish. A short sell can be used as part of a bullish strategy as so can skew the basis for interpreting the ratio.
That's all for today.
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