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What is shorting a stock? What is going long?

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  • What is shorting a stock? What is going long?

    If you gamble, and you ever play craps, think about how there are two different ways to wager: betting that the shooter will make his point (the PASS line) and betting against the shooter, that he will crap out (DON'T PASS LINE).

    Similarly, in the stock market, there are two ways to "wager" on a stock's movement. The traditional way, that most anyone may understand intuitively, is to go LONG - that is to purchase shares of a given stock at the price being offered at that moment, allow time to pass, hope that the stock price goes up, and then, sell the stock at the higher price people are willing to pay and book a profit. Simply put, buy low, sell high.

    Naturally, if one purchases a stock long - goes long - and its price goes DOWN, then there is no profit to book and you will have a loser on your hands, at least so long as its price remains below where you bought it at.

    Shorting a stock is the opposite of that: in shorting, a person bets that the price of the stock will go DOWN, not up. That part is simple enough: on a short you "offer" the stock at a high price, and then "obtain" it at a lower price after its price has fallen. How exactly a trader is able to do this, is a little hard to imagine, but it works like this:

    In order to short a stock, you must somehow obtain shares of the stock and offer them for sale. When you enter an order to short a stock, your broker first determines that shares are available to be "borrowed" to sell, and then borrows the stock from someone else who is holding it. Wait a minute, you say, borrows what? How? Well, rather than get caught up in the intricacies of how exactly all that happens, just accept that when you enter an order to sell short a stock, you yourself own nothing, and rather - you are allowed to borrow someone else's shares to sell to someone.

    That is the opening of the short position: you sell the stock short.

    To close it, you must actually buy these shares - presumably at a lower price (you hope, because you were betting that the stock price will go down) - in a process known as "buying to cover." What you are doing there is buying the stocks to "cover" your short - to replace the shares that you borrowed from someone else. This is where you hear the expression "shorts covering" which means that those who were in short positions are covering their positions by buying stock.

    So, in a long, you buy and then sell. In a short, you do it backwards, sell and then buy. (In fact in some brokerages, there is no "sell short" or "buy to cover" order - just a BUY and a SELL button - if you hit the sell button while you have no shares, on those brokerages, you are presumed to have wanted to sell it short.)

    Going short is not something you do lightly. For one thing, there is unlimited potential loss when going short. If, for example, you sell a stock short at 60 and it starts going up and keeps going up, it could keep going up up up infinitely (in theory) and you'd have to cover all that rise when you covered.

    (On the other hand, when you go long, the most you may lose is the entire purchase price you paid for the stock, if it drops to zero.)

    There are definitely times when going short works. For example in a dropping market. Another time to go short might be when a stock has risen rapidly, and you are betting that it will drop off, at least temporarily. There are two major rules to going short, neither of which you really need to think about, because your broker will address these automatically and not allow you to go short unless both are satisfied:

    (1) the shares to go short must be available to borrow. On some stocks, the short interest is so great that a given broker simply may not find any shares to borrow for you to sell short. This happened not long ago on the stock GPRO where SO many people were short on it that at most brokerages, including mine, no more shares were available to borrow for a short.

    (There are a few ways that long stock holders may stop people from using their shares to go short:

    Some long term stock holders demand physical stock certificates of their shares. This practice, of retaining the shares in your hand, prevents them from being borrowed and used for shorting. In these electronic days however, no one really does that anymore and your shares are just deposited via some trust agreement with your broker, and while deposited, yes - your broker may lend out your shares for shorting.

    There are a couple of other esoteric ways to prevent your shares from being shorted. One is to place a Good Til Cancelled (GTC) order on your stocks at a ridiculously high price, that you know won't even fill, and as long as that order is in place, your broker will have to keep your shares on hand for potential sale and will not lend them out. Another is to trade only in a cash account disabled for margin. Margin is a means by which you are allowed "instant credit" (usually 50-50, or double) to increase your buying power.)

    The second rule of shorting:
    (2) The uptick rule. An uptick refers to a stock's rising - by one tick, which in the old days, was a 1/16 (nowadays an uptick is .01, as we're all decimals no more fractions), but basically - an uptick means - that the stock just went up. After the Crash of 1929, and a similar sort of panic in 1937, in the U.S. you were allowed to go short only on an uptick. This rule was removed in 2007, and a modified form implemented in 2010, that does not apply to all securities, and is triggered only when a stock's price decreases by 10% or more from the previous day's close. Pursuant to the uptick rule, if a stock was simply crashing down, no uptick in sight, you would not be allowed to short it. In practice, this sort of straight downward movement happens rarely, as usually stocks tick up and down in a matter of seconds as they cycle up and down.

    Some refer to shorting as the "other side of a double edged sword" - or a means to profit on a stock's rise AND fall. If you get it right, shorting may very profitable and there are even short opportunities on a day that a stock skyrockets (although in general - it is best to go with the trend, and go long when a stock is rising).

    Consider this chart for example of NFLX from February 11, 2015: Click image for larger version

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    NFLX that day opened at 453.81, went all the way to 462.99 and then gradually went down to as low as 451.9 and then gradually went up to about 457 until it went down to close at about 454 and change. All along the way the stock went up and down - the greens represent ups, and the reds, downs, such that at many different times you could have gone long, or short, for a half point or point or more. Basically, on this day, unless you went long at the top, or short at the very bottom, you had a chance to make some money. The chart doesn't always look like this - every day is different, but as you study a stock and learn its patterns, it starts to behave in a way that you may at least somewhat guess, whether to go long, or short.

    So from the point of view of the OVER ALL action - one might say, well how could anyone have made money on that stock that day, it closed pretty much exactly where it opened. But that's where the end sum isn't all there is to the story - the stock had a ten point RANGE that day, where there were plenty of opportunities for good trading.

    Keep in mind that in general, a short position is a TEMPORARY one
    Shorting stocks - Free EBAY, PayPal, Business and Law Forums - Ebay Suspension, PayPal Limited
    that you hold only until the stock drops enough for you to cover at a profit. Certainly if a stock KEEPS falling you will want to maintain your short, but in general, unless the company is headed to flat out dissolution (in which case you would lose out anyway because at the end of the line there would be no shares left to buy, with which to cover), you will want to stay on top a short closely, and cover at some point before the stock starts rising again.
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  • #2
    damn.....good info bro


    • #3
      When you short a stock, the shares are borrowed by your broker for your use, and then later when you buy to cover, the borrowed shares are returned.

      On some very hard to short stocks where there are very few shares available to borrow and the demand to borrow the shares is high, you may have to pay interest on the loan of the shares (against their value). This is called a "borrowing charge."
      Restrictions and Borrowing Costs |

      For example on SHAK
      SHAK - Shake Shack Inc. stock - Free EBAY, PayPal, Business and Law Forums - Ebay Suspension, PayPal Limited

      the annual interest rate on borrowed shares was as high as 210% recently!
      Expensive Shake Shack short bets may have paid off
      A 210% APR on SHAK based on its recent levels would translate to $1.29 per share per week. In other words, SHAK would have needed to drop by MORE than $1.29 a week (which it did this past week - it dropped by over seven dollars) just to break even on the buy to cover.
      Please read the forum rules before you post.

      And if you need extra help:
      Modee Tech Support