What is short selling?

When investing in stocks there are different investing techniques that investors will use in order to get the highest return possible. Those who make the most money in the stock market are the people who have different strategies and techniques that they use. These people learn to analyze stocks and then find investing techniques that work well for them. They then practice using these techniques over and over again until eventually they have more gains than losses.

Investing in the stock market can be very risky. Unlike a bank, your money will not stay safe. You will either gain a lot or lose a lot. In a bank you have a set amount of interest that is returned to you on your money, but that set amount is not very high. In the stock market you invest but your money is not safe. It is the hope of the investor to invest somewhere that will go up and give them a higher rate of return than they can get in a bank. They are willing to take a risk in order to get more money.

One thing that people do that is very risky but can also have a great return is short selling. If you are going to be a short seller you will have to be very good at analyzing stocks and predicting how companies will trend in the future. Will they go up or will they go down? Being a successful short seller really depends a ton on your ability to analyze stocks. Short selling basically means that you sell high and buy low.

This seems a little backwards because usually in the stock market you want to buy low and then sell high. You buy as many shares as you can when the prices are down and then they will go up and you will make a great profit. Short selling is opposite of this. A short seller sells stocks that he does not actually own while the prices are high and then buys them back once prices are low, making a profit.

The process is really not too difficult. A short seller will go to a broker and borrow money or part of the stock in order to sell it. He sells it at its high price in hopes that the prices will go down. If the prices go down, he buys back his shares at the low price and gets to keep the difference between his sell and his buy. All these words may seem confusing so here is an example:

A man analyzes stocks and determines that a stock that is now worth twenty dollars a share is going to drop soon. He goes to a broker and borrows two thousand dollars worth of stocks (one hundred shares) so that he can go and sell them. He sells these stocks and soon the stock drops to ten dollars a share. He then will buy back the 100 shares in the stocks while the prices are down and it will only cost him one thousand dollars. He will return those stocks to the broker but he can keep the difference meaning he made one thousand dollars off his short sell.

This is a great idea but it is bad if the investor anticipates wrong and the prices of the stocks do not drop. Say the stocks went up by ten dollars rather than down by ten dollars. This would mean he was one thousand dollars in the hole. He would have to buy back the shares to return to the broker but it would cost him three thousand dollars and he only sold them for two thousand. This is where short selling is risky. It would be hard to avoid mistakes like this.