The Basics Of Short-Selling
Posted: Aug. 18, 2017, 8:29 a.m. by jprobasco
Short selling involves selling shares of stock you do not own (that you have “borrowed”) in hopes you can later buy the shares for less than the sale price, replace the shares you borrowed and turn a profit at the same time.
Investors sometimes “short” a stock to hedge the downside risk of a long position they have in the same (or a similar) security. The risk of loss in a short sale is theoretically infinite and makes this tactic suitable only for experienced traders.
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Short Interest/Short Interest Ratio
Short interest is a metric used to track how heavily a stock has been sold short and refers to the total number of shares sold short as a percent of the company’s outstanding total shares.
Short interest ratio (SIR) is the total number of shares sold short divided by the stock’s average daily trading volume. When short interest and SIR for a stock is unusually high, that stock is said to be at risk of a “short squeeze.” A short squeeze is defined by a rapid increase in the price of a stock when short sellers cover their positions resulting in high demand that drives up the price of the stock.
Dangers Of Shorting
Aside from the inherent danger in high short interest or SIR, it’s important to know that if you short a stock there is no guarantee you can repurchase a shorted stock at the price you expect or whenever you decide to make the purchase. Simply put, if there are no sellers, you can’t be a buyer.
Also, you may expect a shorted stock to follow a gradual progression from its price now to the price you expect down the road, but that may not happen at all. The price of the stock may jump up or down suddenly – especially if there are rumors of a buyout or merger.
Finally, know the rules for shorting. For example, you can’t short a penny stock. Also, before you begin shorting the last trade must be an uptick or zero-plus tick.
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The Shorting Process
The process of shorting a stock is simple – at least regarding the process. Start by contacting your broker to locate shares of a stock you believe will go down in price. Your broker will locate the shares and “borrow” them with a promise to return them by a prearranged future date. You will have to pay fees or interest for the privilege of borrowing these shares.
Sell the shares you have borrowed and pocket the money. Wait for the price to fall and buy the shares back at a new lower price. Return the shares to the brokerage you borrowed from and the difference is your profit.
The FinanceBoards Quandl Equity Short Interest widget displays the Settlement Date twice per month from May 2012 to the present; the short interest; average volume; days to cover for a given equity.