Question: Short Selling Question?
The Stock Price Sinks (stock goes to $40)
Borrowed 100 shares of XYZ at $65 $6,500
Bought Back 100 shares of XYZ at $40 $4,000
Your Profit $2,500
The Stock Price Rises (stock goes to $90)
Borrowed 100 shares of XYZ at $65 -$6,500
Bought Back 100 shares of XYZ at $90 -9,000
Your Profit -$2,500
Okay I am reading very reliable information here on investopedia.com...and I can not simply grasp this concept. You borrow shares from your broker, hoping they will go down. By them going down you buy to cover or something and you gain profit? Is it hypothetically you make profit because the stock was once at that price? I hope you understand where I am coming from. Can I Short sell without a broker?
Thorough, non copy and pasted/automated answer gets best answer 5 stars for answering my confusing dilemma.
Answer:
Easy one first - you cannot buy and/or sell without a broker.
The profit/loss is not hypothetical. When you sell the borrowed stock,, your broker deposits the cash in your brokerage account. Then, when you buy to cover, the broker uses the money in your account to buy the stock. If you do not have the money (i.e., price increase), the broker will start charging interest (you have to pay interest on the borrowed stock anyway) as if the difference was a loan (which it is) and make a call for you to cover. Before Selling short on your first go'round, check the terms of your agreement with the broker.
You cannot trade at all without a broker. You cannot sell short without a margin account.
It's just the opposite of going Long. It's the reverse.
Forget about "borrowing" and all that back-office crap. As long as you know the stock is borrowable, you're good to go. Instead of buying first, you sell first at a high price. Then you buy it back cheaper. What's difficult about that?
There's a contract you sign that allows you to do that, and all the terms are set forth for borrowing stock and giving power to do that, and how and when you'll return the borrowed stock, and the interest you'll pay, but all of that is useless information to the actual trade.
You sell at $10, buy it back at $9, and you make a buck.
To be more specific and explicit, you sell short to open a position, and buy to cover. Read the book by Lefevre, Edwin - Reminiscences of a Stock Operator - about Jesse Livermore, one of the most famous short-sellers ever.
Once you know you can do it, just reverse the usual plan of going long, and watch it drop.
<<<The Stock Price Sinks (stock goes to $40)
Borrowed 100 shares of XYZ at $65 $6,500
Bought Back 100 shares of XYZ at $40 $4,000
Your Profit $2,500
The Stock Price Rises (stock goes to $90)
Borrowed 100 shares of XYZ at $65 -$6,500
Bought Back 100 shares of XYZ at $90 -9,000
Your Profit -$2,500>>>
Let me rewrite the two examples a little:
The Stock Price Sinks (stock goes to $40)
Sold 100 shares of XYZ at $65 $6,500
Bought Back 100 shares of XYZ at $40 $4,000
Your Profit $6,500 - $4,000 = $2,500
The Stock Price Rises (stock goes to $90)
Sold 100 shares of XYZ at $65 $6,500
Bought Back 100 shares of XYZ at $90 -$9,000
Your Loss $9,000 - $6,500 = $2,500
The changes I made were
(1) I changed the word "borrowed" to "sold". It is true that the shares were borrowed, but that was done by the brokerage and you did not have to worry about it. The important thing was that you sold the shares for $65 each so you received $6,500.
(2) In the example where the stock price goes to $90 I changed the amount at $65 from -$6,500 to $6,500. Because you were paid cash for the shares, you received $6,500 just as you did in the example where the stock went to $40.
(3) Since a negative profit is a loss I changed the final line to show a loss of $2,500 instead of a profit of -$2,500.
(4) In both examples I added the calculation to get the $2,500 profit/loss by subtracting the small number from the larger number.
<<<You borrow shares from your broker, hoping they will go down.>>>
True, but the important thing is that you received cash representing the price of the stock because you sold the shares.
<<<By them going down you buy to cover or something and you gain profit?>>>
Leave out "or something" and that is correct.
<<<Is it hypothetically you make profit because the stock was once at that price?>>>
No. It is a real profit because you sold the stock for more than you paid for it. If you buy a stock for $40 per share and sell it for $65 per share you make a profit of $25 per share. If does not matter which transaction was done first.
<<<Can I short sell without a broker?>>>
No. You need the broker to supply the shares you sold when you shorted the stock.
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Let me give you an example of a short sale of something other than stock. Assume you own a store that sells cell phones. The new Iphone 12 comes out and is in short supply. Because there is not enough supply to meet the demand you can sell them for $900 each. You also allow people to buy them on layaway. When Mr. Jones buys one on layaway you put a slip of paper on an Iphone saying the phone has been sold to Mr. Jones and will be delivered when he has paid the balance due. You then put it in a back room with the slip of paper.
After you have sold all the Iphones you received in your initial shipment another customer comes in and wants to buy one. You go to the back room and get Mr. Jones' Iphone and sell it for $900. You are betting that you will be able to get a new Iphone from your supplier for less than $900. If you are right, and can buy it for $600, you will have made a profit of $300. If you are wrong, and have to pay $1,000 for it, you will have a loss of $100.
You sold Mr. Jones' Iphone before you bought the Iphone you eventually give to him, hoping to make a profit from the decline in the price. When you short a stock you do the same thing. You sell something you do not own planning to buy it back later for a lower price.