The Real Scoop on "Selling Short"

You may be familiar with this strategy, but if not, "selling short" is a way to make money from a stock that is going down. Interesting, huh?

We're going to talk briefly about selling short because we want you to understand how this strategy works, but here's our straight talking advice right up front: We don't recommend using this strategy...in fact we recommend that you never "short" a stock!

Yes, you can make a lot of money quickly by selling short, but—and this is a BIG but–short selling is very risky. You can also lose a lot of money very quickly.

Here's how it works: When you expect a stock will decline in price, you can sell short. By selling short, you sell something you don't own. You borrow the stock (more on how in a second) and promise to replace the stock later. Why? Because you believe you buy it back cheaper, later on, and pocket the difference.

You borrow the stock from your broker and then immediately sell it. Then, if the stock takes a tumble as you hope, you buy it back at a lower price, return the stock to the broker to "cover" what you borrowed, and your profit is the difference between what you sold the stock for and what you bought it back at.

Here's where it gets tricky, though. You are obligated to buy the stock back and return it to the broker at some time in the future—even if the stock price never goes down. If the stock price goes up, you have to come up with the extra money to buy the stock back. To be a successful short seller, you need to have extremely good analysis and crystal-clear thinking. You have to know all the details of the stock before you buy. And you need a large tolerance for risk.

That's not the way we recommend you invest.

For more smart investing techniques, check out these links:

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