SHORT SELLLING STOCK, Part 3

Part Three THE THREE PLAYERS

The process is simple in explanation, but a bit more difficult in real life. To understand this better, let’s look at what each person gets out of this deal. You, the investor make money if the stock performs just like you want it to, meaning it goes down in price. You have an obligation to pay back the loan with stock, and a little interest.

This is going to get pretty heavy-duty so let me lighten the load with an attempt at humor. Getting these trades right is like the short, (pun intended) fat guy. He knows he should work out, but .  .  .

THE INVESTOR—YOU:

You have to be aware of things. For example, your brokerage firm will not let you conduct this type of trade without enough cash in the account to buy the stock. Yes, this can be done on margin, but there could be a double whammy there. If the stock goes up, even before you close (voluntarily or involuntarily) out the position, you may have to bring in more cash. That requirement may be difficult.

If the $20 stock is used, then at least $10,000 must be in the account. If the stock goes to $30,000, you might have to bring in more cash or securities. If you don’t, or at the whim of the brokerage firm, they will close out the position. See the 3rd point below.

Again, a reminder, this is a bearish trade. You should never conduct this trade if there’s a chance the stock can go down, and there is always a chance. Granted, short-sellers can and do make millions, but this is you. How’s your luck?

Also, granted, gravity often aids this short-selling process. Stocks seem to go down much faster than they go up. If you want to trade the whole market, you can do this with ETFs, like the DIA, Dow 30.

THE LENDER:

This is the person or company contacted by your brokerage firm. He is usually one of their other investors. However, he or she may be contacted through the grapevine.

This person has to decide if he/she wants to lend you the stock. There is little risk to them. They will get the stock back whether it goes up or down. So this risk of theirs’ is not new. If they have a $20 stock, and it goes to $15, so be it.

By lending their stock to a short-seller, they earn the interest. It’s not much these days, but it is something. If the stock goes up to $25, they get it back. You lose but they are made whole.

THE BROKER:

When you call your brokerage firm to conduct this trade, they will take the information and call you back. I’ve never had them do the trade instantly. It takes time to put all of the moving-parts in place.

First, they will look to their own positions. Do they have this stock? And even if they do, are they willing to lend you the stock? They can’t do anything with this stock until this position ends, and a small investor may not be able to wait for that to happen.

Next, if your brokerage firm does not have this stock, they will scour their own client’s positions and see if they can find someone willing to do this lending side of this trade.

Part Four Coming Soon

Stock MarketWade Cook