Course 202: Using Financial Services Wisely
Shorting
In this course
1 Introduction
2 Full-Service Brokers
3 Fee-Based Planners
4 Discount Brokers
5 Market and Limit Orders
6 Buying on Margin
7 Shorting
8 The Bottom Line

It may sound funny, but investors can actually profit when a stock goes down in price. Shorting stocks involves selling borrowed shares with the intent of repurchasing them at a lower price. Instead of trying to buy low and sell high, you are simply reversing the order. Once again, let's go through an example:

You've been tracking fictional company Badgers Bricks Corp. and think its newest products are going to flop. The company is already on the ropes financially, and you think that this may be the last straw. You decide to short 100 shares of the company. After an order to short Badgers Bricks Corp.'s stock is placed, your broker will find 100 shares that it can lend to you. You immediately sell those shares on the marketplace for $10 and receive proceeds of $1,000. If the stock drops to $8, you can buy the shares for $800 and return them to your broker. Your profit is $200 ($1,000 minus $800).

This sounds easy enough, but no investment is foolproof. If you make the wrong bet when shorting a stock, your downside is potentially unlimited. In a best-case scenario, the stock you short will go down to $0 and your profit equals all the cash you received from selling the borrowed shares. On the downside, the stock you short could increase in price, and there is no limit on how high it may go. Remember, those shares are borrowed and eventually will have to be returned. If the price keeps going up, you'll be stuck paying a lot more to buy the stock back, perhaps much more than you could have made if the stock went to zero. The important thing to remember is that the potential downside in shorting stocks is unlimited. As with buying on margin, be careful.

Next: The Bottom Line >>


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