For many people the world of stocks and shares is almost like an alien land – a space they know exists and always seems to be frantically busy, but yet few of them will really know anything about what goes on there. That’s a pity really, as although there are lots of words and terms which are specially used in stock exchange commerce the entire process is a lot less mysterious than it may like to be seen as.
Here we look at just one aspect of the stocks and share marketplace – offering a guide to how you, (which means anyone keen to make the effort to understand the basics), can both get involved in one aspect of it – namely how to short a stock – but to also learn how to do this very well. Successfully shorting a stock means you make a profit, and that has to sound good, right?
So keep reading to learn how to earn.
What’s investing all about?
The traditional way people gamble on the stock market is by trying to identify company shares they believe will grow in value, either in the short or the long term. Buying shares for that reason is called ‘going long’, based on taking a longer-term view. Although some people do this as their full-time job, advising clients on building a long term profitable portfolio, there are plenty of hobby broker’s who enjoy the research, reading and speculation it involves.
So what does shorting a stock involve?
Basically, this means buying shares you believe will fall in value. Also known as ‘short selling’ or ‘stock shorting’, this is said to be a more difficult thing to do than buying long. That could be because it’s easier to identify the potential signs of company growth, or other factors which could trigger that, and also simply because most of us are programmed to assume buying shares is all about making investments for growth, not a loss.
Of course, nobody tries to identify potential shorting stock opportunities just for fun, with no thought to the money involved. Successfully shorting a stock is a task which requires planning, skill, knowledge and a very high level of patience, but ultimately it is a strategy to make a profit, albeit in an alternative way to the traditional buying and selling of stocks and shares.
1. You have your broker source the shares of the stock you believe will lose value.
2. You now have the ‘borrowed’ shares, which you sell, and keep the cash to one side.
3. When the price of the shares falls you buy them back again, obviously for less than you sold them for.
4. You send the shares back to the broker, pay them a fee for the favour, and keep the rest of the money made as profit.
Note – so long as everything goes this smoothly then you have achieved your goal of successfully shorting a stock, but there are potential dangers. For example – if a dividend is paid from the company during the period you hold the stock you will need to cover that payment. Plus, if for some reason the stock doesn’t fall in price, or at worst it actually recovers, you will need to buy it back at whatever the price tag is, and still pay the brokerage fees! This is why you need to build your skills and take things slowly, as more experience will help avoid that kind of hiccup.
A clear guide to actually shorting a stock successfully
Here we will outline the basics of each step so you can understand the underlying features and the critical elements of successfully selling stock short as and when you wish too in the future.
This can be ongoing, so as you become more familiar and comfortable with the process you could expect to have several sets of research on the go at the same time. You may need to use several sources to dig out the information needed to be successful, including reading relevant sources both on and offline, as well as networking with relevant connections, and building loyal contacts in as many places as possible.
What to look out for:
The technical side
If you are new to things look for examples of previous successful short selling incidents and create charts depicting the way it fared in the build up. This helps to identify common patterns and trends which are exactly what experienced traders are looking for. These may include particular periods of continued downward activity, or the asset price falling below a particular level.
Companies produce estimates for each quarter year ahead of time, and failing to meet one of these should trigger red flags and put them firmly on your ‘possible’ list.
Anything from reports of illness from particular food producers/distributors, to car recalls or major personal scandals which capture public attention and opinion can be enough to start toppling a company’s value – even if only for the short term.
The slow rot
This is one of the easiest to spot signs of a potential stock shorting opportunity. Look for major shareholders starting to offload their shares, reports of lower than average profits, low future profit predictions, loss of major clients, bad publicity and so on. Once a company starts showing a few problems people assume there are more to come and lose confidence quickly. Of course, you want the shares to recover fairly quickly so are looking for temporary blips, not signs of a company about to go under completely.
Some closing thoughts
Most successful short sales arise from a company’s value being over inflated for some reason. This rarely lasts, but if you got in and managed a short sale then when the market returns to normal you have made a killing. Successfully shorting a stock takes patience, bravery, self-belief, improving your ability to make decisions, and really learning to trust in your own intuition.