Rather watch than read? Watch the video at the bottom of this article.

Selling a stock you do not own.

Now we’re going to discuss “What is short selling?” The way I’m going to do that is I’m going to use this fancy graphic that I put together in about two minutes to illustrate what exactly is going on when you short sell a stock.

Basically, what you’re doing is you’re selling a stock that you do not own. There’s always going to be a buyer and you’re going to sell this person a stock that you do not own. How are you going to do that? You don’t own the stock, so your broker is going to lend the shares to you. How they’re going to do that is they’re going to either take the shares from their own inventory and lend them to you or they’re going to borrow them from another client’s account and then lend them to you, so that you can then sell them to a buyer.

You’re going to receive the proceeds just as if you had sold them outright. So say you sold 100 shares at $30.00, you’re going to receive proceeds of $3,000.00, which are going to be held separately in your account. And at some point in the future, you’re going to need to buy back those shares that you sold. If you’re buying them back at a lower price and then you keep the difference between those two balances.

If you buy them back at $10.00, that’s only $1,000.00, you’re buying them back for. But you’ve already received $3,000.00. So after you give the $1,000.00 back to your broker for buying them back, because now you’re paying off your debt, you’re going to have a difference of $2,000.00, which is your profit.

Why would you Short Sell?

Of course, if the share prices go up in value, then you can, of course, lose money. If the share prices went up to $40.00, let’s say. You need to buy the shares back and it costs you $4,000.00, you only received $3,000.00 in proceeds, initially. You still need to give back those shares, $4,000.00 worth, so you’re actually short $1,000.00, or at a loss of $1,000.00 in order to give those shares back to your broker.

So, what exactly is short selling? Short selling is selling the stock, the seller, or you do not own. When you short sell a stock your broker’s going to lend those shares to you. They’re going to do that either from their own inventory or from the stock of someone else that they have an account with. The shares are sold and the proceeds are going to be credited to your account and if the price drops, you buy the shares back at a lower price and you profit the difference.

Why would you short sell? Well, the obvious answer would be to speculate. You want to profit from the downside movement in the stock or stock market. That’s pretty straight forward and that’s how most people are short selling in the markets. Another reason you may not be aware of is you can hedge by using short selling, so, you can protect your other long positions by short selling. So, say you anticipate a down move coming in the market and you have long term positions that you want to protect, you can then short sell shares of a correlated stock, another stock in the same sector that you expect is going to fall, the gains will offset the losses of your long positions if the market falls.

Uptick rule restrictions removed.

There are some restrictions you need to know about when short selling. First, you can’t short sell penny stocks and most short sales need to be done in round lots, i.e., a block of 100 shares, 200, 300, 500 or 1,000 shares.

Let’s take a look at a short selling transaction. So, say you decide that company XYZ is ready for decline. The stock is currently trading at $45.00, but you predict it will trade much lower in the coming months, so you decide that you want to short sell 100 shares of that stock. Let’s just say things go your way. You short sell and the stock price sinks to $20.00 and you borrowed 100 shares at $45.00, you’ve received proceeds of $4,500.00 for those shares and then you bought them back at a later date at $20.00, which is only $2,000.00 that you’re buying them for. You get to keep the difference after you give back the shares to your broker, of $2,500.00.

If things don’t go your way, however, say the stock prices rises to $70.00 and you borrowed 100 shares at $45.00, so you received proceeds of $4,500.00. You buy

How you make money "shorting"

back the shares at $70.00, which is $7,000.00, so you need to pay back that $7,000.00 for the shares to your broker and you’re at a net loss of -$2,500.00 in that situation.

Let’s take a look at some of the risks involved with short selling. The first risk is that the market has a bias to upward prices, so over the long run most stocks are going to appreciate in value. What this means is that shorting is betting against the overall trend or direction of the market. When you short sell, your losses can be infinite; a short seller loses when a stock price rises. Theoretically, a stock price could rise to infinity. On the other hand, a stock cannot go below zero, so your upside for short selling is limited to if the price actually reaches zero.

Shorting stocks involves using borrowed money, otherwise known as margin trading. So if your account slips below the minimum margin level, you’re subject to a margin call. You’ll be forced to put more cash into your account or liquidate your position. Without going into the finer details of margin, let’s just explain it this way. You’re borrowing the stock. You’ve received proceeds which are being held separately in your account and you essentially borrowed that stock from your broker. So you need to put up a percentage of equity value, or buying power in your account to do that.

How you can lose money "shorting"

If the stock goes against you, meaning goes higher in price, you’re going to continue to put up more margin, or buying power in your account in order to maintain that position. If you don’t have enough margin to continue to maintain the position, you’re going to receive a margin call which is going to force you to put more money in, which would give you more margin, or you’re going to need to cover the position, or liquidate the position.

Another risk is if a stock starts to rise and a large number of short sellers try to cover the positions at the same time, it can quickly drive up the price even further. This is known as a ‘short squeeze’. For example, prices start to go up; people are buying the shares, so there’s some buying pressure and if short sellers are in the stock and they notice prices are going up, they may be having their short stop losses triggered, which then causes them to buy the shares back to cover their positions. Now you’ve got buyers and short

sellers who are buying, which is causing a lot of buying pressure, which of course, feeds the price movement which then can create what’s known as a short squeeze, because now there’s a lot of buyers stepping in, as well as the short sellers covering the position in panic.

Bottom line is short selling is a very important tool that you need to add to your trading tactics and techniques. If you’re not comfortable short selling, there’s nothing wrong with that. But you need to stay out of the market is the market is in a nasty mood. If you really want to start trading with a professional mindset, then you need to learn how to use short selling to your advantage and incorporate that into your trading plan.

Example of a short trade

Let’s take a quick look at a chart of Dell, you can plainly see that it is having a rough time in the last couple of months. Clearly it is in a downtrend, if you’re trying to go long on this chart where was the long position that you were trying to enter? Was it somewhere here? Near the bottom as a long entry break out? If that’s what you’re looking for, then your perspective is very short term.

If you were short selling, you can clearly see a nice area of support which was clearly broken, and in fact, actually gaps down quite heavily.

If you didn’t get in on that, fine, but you had an excellent area right here that was short able. Here you see the resistance point was touched by the down trending, 20 period moving average, which gave you a good entry, and then it materializes again, here, with a 40 period moving average acting as resistance.

Where it’s going to go from here, who knows, but there was actually a good little play in there and whether or not this is going to act as major support or not, remains to be seen. We’ll just have to see how this plays out.

Next I’m going to go over a trade analysis of an actual short selling trade that I made recently and I’m going to show you the entry and the exit techniques that I used as well as how I manage my stop losses with a trailing stop and of course, all the other money management I incorporated into that trade.

Finally…. after many delays and general laziness. Here is the first two modules of SmartSCAN Formula. This was going to be a paid product addon to my book Trading Master Plan and based on the time and effort I put into it I was going to charge $97 for it. But because it took so long to get it done and released I decided to just give it away… that’s how I roll.

Module 1 gives you an introduction to SmartSCAN Formula and shows you how to use free tools and scanning methods. I made this module over three years ago (my video skillz have improved since then) and there is over 2 hours of video in this module.

Click Here to Watch Module 1

In Module 2 I show you how to use Stockcharts.com Extra membership to build and filter your watch list. I also show you how to run and build scans and discuss the nightly scanning routine. I made this module last year and it is nearly 2 hours long also.

Click Here to Watch Module 2:

In a couple days I will be releasing Module 3. Which will show you how to use the Swingtracker scanning software.

Enjoy the videos and please leave a comment.