The short sell

OK, it looks like I need to get into this one now. I was going to post a trade setup for Monday but it requires some explanation for the trade first.

The short sell:

Selling of a borrowed stock, the profit comes from a DROP in the price when you buy it back...opposite of a Long Trade in some respects.

Everyone knows what a long position is, buying a stock to hold until the price goes up for a capital gain or there are dividends paid to you as a shareholder. Basically buy low and sell high...pretty simple.

The short is more complicated. I've been asked to explain it a number of times so I think I can break this down easily.

When you deal through a broker you don't actually own any shares, they hold them for you and your account reflects the amount you have purchased. So the broker still owns them, this is important.

You short sell the shares to the market.

In a short sell you borrow some shares of the company you are going to trade from your broker. (Sombody has an account that has bought these shares but not always the case) For example, ABC stock is selling for $15 right now so you sell the market 100 of the broker's shares. The cash for the transaction is not yours, it is basically held in trust. So $1500 is held separately and the 100 shares show up as a negative quantity on your account.

In a short sell, as stated above, you are waiting for the price to drop to make your profit.

The price drops to $12. You decide that the $3 difference is enough and you now have to cover the short shares. Covering is buying the shares from the market to give back to the broker. In my trading software the "BUY" button is also the "COVER" button as they are the same transaction as far as the market is concerned.

You buy or cover the shares for $12 and pocket $300

The shares are covered for $1200 total which can be considered as deducted from the $1500 held in trust. You give them back to the broker. $1500 was held from the sale, $1200 was the cost to "cover" or buy back the shares from the money held in trust so you get to pocket the $300 as profit.

The "short" version is that you short sell the shares for $15 per share, then cover the shorted shares at $12 per share and get to keep the $3 per share.

Three things to remember as you hold a short position:

1) holding over the ex-dividend date you will be responsible to pay the dividends to the broker

2) if the stock splits, you will be responsible for buying the appropriate number of shares to cover the number the split was (2 for 1 you need to buy 200 instead of 100...at whatever price you can)

3) last but certainly not least, if the price goes up you lose the difference. This can have serious consequences unless you depend on your strategy.

This one is sometimes hard to get. I understand that only around 2% of people investing or trading in the U.S. have ever even done a short sell. It is misunderstood. Most of my trades have been short sells and I like them.

JD.