How Does Shorting Stocks Work?
 

Many people think that you buy stocks and wait for the price appreciation to take place to make a capital gain. You can not only buy stocks and make profit when the stock price increases as the market goes up but you can also make profit by selling or shorting stocks as the stock price goes down as the market falls.

What is shorting stocks? You short the stocks by borrowing them from your broker and selling them to another buyer in the anticipation that the stock price will go down. Later on you buy back the stocks at a much lower price and return them to your broker. The difference between the selling price and the buying price is your profit.

Shorting stocks works when the stock price goes down. In case the stock price goes up, you can end up with a loss instead of a profit. Theoretically, the stock price can go up and up making your loss infinite. However, practically this cannot happen as at some stage you will receive a margin call from your broker.

How does shorting stocks work? Suppose stock ABC is selling at $70 and you think that its price will go down in the near future. There can be many reasons behind your judgment. Anyway, you borrow 1000 ABC stocks from your broker and sell them in the market. You get $70,000.

The price does not go down. You had a stop loss of 10%. So the price goes up to $75 but the stop loss is not triggered. Suddenly a bad earnings report for the quarter is released by the company headquarters. The price suddenly plunges to $50. Since the effect of the bad news usually lasts a few days, you wait for two days and buy back the stock at $45. Your cost is $45,000. Thus your profit is $70,000-$45,000= $25,000.

Many active investors look for penny stocks that would have high value in the market. But, the fact is that you can see great profit with the penny stocks which have very less value in the market through shorting stocks. Basically shorting penny stocks means selling the shares that are not owned by the investors but has borrowed those shares temporarily. You can expect that the value of these stocks could get more in some time and you can buy these stocks at the time of the fall down price.