We all know investors like to make money when prices are falling by shorting stocks. But if you’re somewhat of a novice trader (or not), you might be asking yourself how to short a stock the safest and easiest way.
Investors who sell a stock short make their money by gambling on the shortcomings and hard times a company might be facing… the complete opposite of what most people are ordinarily doing. Shorting a stock is especially popular with investors who are willing to risk losing a potentially huge amount of capital.
Short sellers are betting that an asset is going to drop in price. And by selling it now, they believe they can buy it back to return to the lender at a much lower price by the time the stock begins to perform poorly.
When shorting a stock, as always, the first thing you want to do is your research. Which company looks like it’s about to tank on earnings? Is there a restaurant or hotel that has consistent bad reviews? Take all this into consideration when choosing a stock that you believe is going to lose value in the near future.
Now let’s say you find that company XYZ and you’re convinced the stock is about to drop. It’s currently trading for about $15 a share. So after doing your research, you think it’s actually only worth about $10 a share. Your next step is to go to your broker and ask to borrow shares of the stock (let’s say 100), which you turn around and sell them all on the stock market for the current $15 price.
At this point, you now have $1,500 cash in your trading account, but you still owe your broker 100 shares of XYZ. Your short trade doesn’t end until you eventually buy 100 shares of XYZ to give back to your broker.
After a bad earnings report, analysts and investors sour on XYZ and the price drops down to $10 a share — right on target! So you take the $1,500 that you made when you sold the stock earlier, and use $1,000 of it to buy back 100 shares of XYZ at $10 a share. You give the shares back to the broker, and the $500 you have leftover is yours to keep.
So at the end of the day, you just made a $500 profit on a falling stock.
Of course, that’s the ideal scenario. You also have to think about what happens when the price of the stock ends up going higher…
When that happens, you’re exposing yourself to the risk of losing a substantial amount of money
… Because stocks can theoretically keep moving higher and higher infinitely, your risk is also infinite. And that’s pretty intimidating.
So what’s the easiest and safest way to short a stock, without the huge risk of selling shares?
Traders, I think it’s time we went back to the basics and cover how to short a stock… without selling shares.
While I don’t think this method is brand-new by any means, I do think this is one of the safest ways to short stocks without risking your entire account.
When you think a stock is overvalued, instead of borrowing shares from your broker to short it, you can instead buy put options.
There are a couple reasons why this will work better in your favor. In fact, it’s one of my go-to strategies. I’ve laid out all the details in the video below.