by Karen I Livingston

Created on: September 21, 2008   Last Updated: October 23, 2008

Don't Lose Your Shorts!

Shorting stock allows speculators to profit from falling stock prices. The way this is done is by borrowing shares from a broker, selling them into the market, and then buying the same amount of shares at a lesser cost, giving the broker back the shares. The difference between the initial market price and the lower price you purchased the shares at, less the commission you pay to make the trade, is your profit.

The main risk in shorting stock is if the stock does not decrease in value you have only borrowed the shares that you sold into the market and you owe the broker for them, plus the commission. In contrast, and equally risky, is if the stock increases in value. If this happens you will owe the broker the initial market price plus whatever the increase per share was at the time you were able to unload the stock back into the market, in addition to the commission.

To minimize these two risks options' also known as puts' and calls' can be utilized when trading. These guarantee an out should the market go against your position. The cost of these options is determined by many factors.

When looking for a stock to short, a good value isn't limited to the price per share. Understanding the industry of the stock it represents will better enable you to determine the direction it is headed and allow you to make an educated decision regarding the stocks future, theoretically putting yourself in a position to take advantage of declining stock. This knowledge makes the stock valuable to you.

As for techniques and strategies:

Do your research. Trade in stocks you understand.

The best short sellers, known as bears, sell into a buyer's market and those same bears cover in a seller's market.

Follow trends; the majors lead the minors. For example: if the largest brokerage house on Wall Street fails, it's a safe bet smaller houses will follow.

Keep abreast of what the successful trading houses, such as GSCO (Goldman Sachs) are doing, and stay in their wake. Don't jump out in front of them.

Short seller markets tend to slow down toward the end of the week. Keep in mind a lot can happen over the weekend that affects how the market opens on Monday.

Seconds count. Being able to anticipate the market and execute a move is key to a successful short.

Just as an instrument-rated pilot has to sequester their fear and fly by facts, so must the short trader do the same with their emotion.

Overall, as a short seller, if you're successful, many may view you as a market genius, part of an elite group who are in the know. If you're a loser, you may be viewed as a gambler, jeopardizing for some easy money or the big payoff. Either way, you're a player in a huge game that can make or break you with one move. And, by the way, it's not easy.

Long before you make your first trade learn the language, learn the methods, and know your limits. Do a lot of paper trading to get acclimated to market rhythms. When you're confident with your ability go live and get ready because it's a wild ride!

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