With a traditional stock trade, you buy a stock in hopes that the price will go up. But if you feel that the stock market as a whole, or a single stock in particular, is poised for a fall, you can make money in that scenario as well. When you sell a stock short, you make a bet that the stock is overvalued and that its share price will fall. Short selling is not without its risks, but if you are a sophisticated and experienced investor you might want to give it a try.
Open an account with a traditional or online broker. Review the terms of your account to make sure it allows short selling. Some brokers allow short selling by default, while others require investors to complete a separate application to activate short selling privileges.
Log on to your account and enter the ticker symbol of the stock you want to sell short, along with the number of shares you want to transact. Review the details of your trade carefully before sending it for processing. Print a copy of your trade confirmation and keep it with your tax records.
Set a mental stop past where you will not continue the short position. One of the biggest risks of selling short is that the downside potential is unlimited. If you buy a stock at $10 a share, the most you can lose is the amount you put in. But if you sell a stock short at $10 and it goes to $100, or $200, or $300, your portfolio could be in a lot of trouble. As long as the short position remains open, you are still required to purchase those shares and eventually cover your short. Setting a mental stop limits your downside risk. In the example above, for instance, you could set a mental stop for $20 per share. You would lose money on the transaction, but you would also eliminate the possibility of even bigger losses.
Determine how far the stock price has to fall before you take your profits and cover your short position. Setting a mental stop allows you to lock in your profits and avoid getting trapped in a situation where the stock drops sharply, only to rebound past where you sold it short.
Track the price of the stock on a regular basis and be prepared to cover your short position when the stock falls to the price you set. Log on to your brokerage account and enter a purchase order. Use the "Buy to cover" option to close out your short position and take your profits.
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