How to Short a Stock
When you short a stock you are basically taking the other side of a “long trade.” A long trade is the same as someone buying the stock. For example: Someone buys 100 shares of IBM at $50.00 a share. This means they will have $5,000.00 taken out of their account (remember this) used to purchase the shares. Now you think that IBM will go down in price and you want to short the stock. So you put in an order to short 500 shares of IBM, now what happens?
The brokerage house goes into the market and finds people who have long positions in IBM, and lets say you short IBM at $50.00 a share. Now the transaction becomes a war between the person who bought the IBM shares and you. At this point it’s sort of a poker game, and the price movement of the stock determines who wins or loses.
Making Money on a Short Stock: If the price of IBM goes down to $40.00 a share, then you win. This is what happens: The person who bought IBM at $50.00 a share loses $1000.00 (100 shares x $10.00 loss). Their loss is your gain because you bet the stock would go down, and remember they put up the $5000.00 in the first place to buy the shares.
Losing Money on a Short Sale: If we take the example above and reverse it, we have the exact opposite results. If IBM goes up to $60.00 a share, then the person who bought the shares makes $1000.00. And since by shorting your money is now matched up against the buyers money, you have to dish up the $1000.00 for their profit.
Shorting a stock means you’re betting a stock will go down, and down means the bottom is zero. The risk in shorting a stock is the unlimited potential a stock has for going up in price, it’s virtually unlimited. This is where the risk lies for someone who wants to short a stock.