Selling a stock short means selling a stock that you don't own. Since you can sell something you don't own but not something you don't have, you have to borrow the stock if you want to sell it short. As with other things you borrow, you have to pay interest if you borrow stock. In addition to having money in your account when you first short the stock, you must put up additional money if the stock goes up instead of down. So this is not a game for the penniless investor to play.
When you sell a stock short, the goal is to buy it back after the price has fallen. Then you return it to the owner. Although the buy-sell order is nontraditional, buying the stock at a lower price results in a profit on the shares you sold at the higher price. If the stock moves against you and goes higher, you may ultimately have to buy it back at a higher price. Since a stock can rise to a theoretically unlimited price, shorting a stock can involve substantial risk. You may have to buy the stock back at a much higher price than the price at which you sold. To help reduce this risk, firms require you to have at least some money in your account if you want to sell a stock short.
The Financial Industry Regulatory Authority requires you to have at least $2,000 in your account if you are going to buy stocks on margin, or 100 percent of the value of the stock if less than $2,000. Since shorting a stock requires a margin account, this minimum margin requirement applies to short sales as well. Many firms, including Charles Schwab and Fidelity, require you to have at least $5,000 in your account if you want to sell a stock short. When you short a stock, you can use the proceeds of the sale to fund the margin requirements, but you must keep the cash in the account.
At all times, FINRA requires that you have at least 25 percent of the value of a shorted stock in cash in your account. For example, if you short 100 shares of stock at $20 per share and it goes up to $30, you must have at least $750 in cash in the account. Some firms require as much as 40 percent in maintenance margin, in which case you would need $1,200 in cash equity in this example.
If the equity in your account falls below the threshold established by your firm, you may face a margin call, requiring you to immediately deposit more money. If you don't contribute enough money, the firm may cover your short position and saddle you with the bill. For example, say you shorted 100 shares of stock at $20 per share and it skyrockets to $50. The firm will likely buy back your position at $50 if you don't deposit more money. Since you only received $2,000 from the sale of your stock, you will still owe the firm $3,000, plus interest.
After receiving a Bachelor of Arts in English from UCLA, John Csiszar earned a Certified Financial Planner designation and served 18 years as an investment adviser. Csiszar has served as a technical writer for various financial firms and has extensive experience writing for online publications.