By Kristin Hovencamp, CPWA®
Traditionally, short selling, or shorting stock, was once thought to be a trading strategy employed only by professional traders and hedge fund managers. Today, retail traders have increased their short stock interest. Short selling as a tactic is used to profit from a decline in a security’s price and is the opposite of buying a long position and betting that the price will go up in value.
A short sale occurs when a seller borrows shares of a security from a broker-dealer. The borrowed shares are immediately sold to buyers willing to pay the market price. A short seller is anticipating they will be able to repurchase and replace the borrowed shares in the future at a lower cost. The borrowed shares must be returned to the lender by a specified date. The difference between the stock sell price and the buyback price is the short seller’s profit or loss.
Seller beware. The risk of loss on a short sell is unlimited because, in theory, a stock’s price can rise as high as the market is willing to pay, whereas, when you buy a security, the most you can lose is the cost of your investment.
Short sellers must place trades using a margin account. Margin allows you to buy and sell securities by borrowing money from a broker-dealer. Because you are investing with borrowed money, you are using leverage, increasing the potential profit or loss of your investment.
Capitalizing on falling asset prices has gained momentum amongst retail traders and is no longer a strategy limited to professional short sellers. To persevere in the high-stakes arena of short selling, one must have a bearish view of the market or a particular security. That said, “You don’t see any Fifth Avenue mansions built by bears,” James R. Keene.
Kristin Hovencamp, CPWA® is an Investment Executive and Director of Business Development with HAZLETT WEALTH MANAGEMENT, LLC, which is independent of Raymond James and is not a registered broker/dealer. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. 675 Sun Valley Road, Suite J1 + J2 Ketchum, Idaho 83340 208.726.0605.