When an investor shorts a stock, it means that they are betting on the price of the stock dropping. In theory, it’s the same thing as betting on a sports team to lose. Unlike traditional trading, the investor will never actually own any stock during the shorting process. During the short selling process, they are essentially borrowing shares. They then will sell the stocks back at the current market price, betting that the price of the stock will have decreased before they are forced to repay the stock, so they can pick it up cheaper.
To completely understand the shorting process, you will need to know:
The goal of short selling is to profit off of a company’s stock declining, or the company going bankrupt before a certain date, known as the expiration period. The short seller will agree to sell the buyer a stock for the price it is currently valued at and hopefully profit from the stock’s decline by being able to buy it at a lower price and sell it to the higher market value in the original agreement. By the end of this borrowing, the trader will pocket the difference after it has been adjusted for any dividends.
The dividend income will come out of the short seller’s pocket to cover the cost that is no longer available for the original shares. One drawback is that if the stock is borrowed through a brokerage firm, then the dividend replacement will not count as qualified dividends entitled to specialized tax rates.
To understand why investors short stocks, it is crucial to understand how the process works. Say, for example, that you are looking to short 200 shares of ABC Company because your research has predicted that they will have lower-than-expected next quarter earnings. When you began the process, the stock was trading at $38.50 per share, and you intend to borrow the 200 shares from your broker for a total value of $7,700. With this situation, there are two possible outcomes.
Another example to help you better understand what is involved in short selling is deciding to purchase stock from XYZ. Through your research, you have determined that the stock is grossly overvalued and likely to experience a plummet in the near future. You decide to borrow 20 shares of XYZ stock from your broker and sell them at the current higher market value. The end goal is to repurchase them when the stock plummets and give them back to the broker to settle, pocketing whatever the difference is.
One important thing to note about short selling is that many brokerages may restrict your ability to short trade to whether or not you have a margin account. Cash accounts with no margin are often not used for short selling. This is due to the fact that the potential losses when short selling can be unlimited. So for those who wish to prevent short sellers from borrowing their shares, it may be best to open a cash account with the brokerage instead of a margin account to have greater control.
Since short selling is high risk and requires a margin account, that means that you will be personally guaranteeing the money to cover any losses. If you don’t have the cash funds available to cover a margin call, you will be unable to pay it back with payments. Instead, you would have to liquidate your assets to come up with the funds.
This can mean catastrophic consequences for investors who are not as experienced or may not fully understand the possible risks. A more experienced investor will try to cover their exposure to risk by creating offset protections, such as buying out-of-the-money options that are matched appropriately.
Short selling can be an extremely profitable transaction, does not require much capital to get started, and can allow investors to still actively make money even in a down market. Many short sellers will perform these kinds of investments just for speculation. For other investors, it is a way to hedge the downside risk in a long-term position. When investors do this, they will already own shares of the same stock or a related stock.
There are also some investors who enjoy more risky investments and have put their work in, researching and following stock trends to ensure they are making informed and smart decisions about which stocks to short to maximize profit and minimize loss.
As mentioned before, selling short can expose you to a significant financial risk. In some cases, investors may see that many speculators have shorted a big percentage of a company’s stock. This can show a large short interest. When seeing this, some companies may drive the stock price up to force all of the short position speculators to purchase back their shares early to reduce the risk of paying even higher prices, and the shares continue to rise. This provides some control over the price of the stock before all of the speculators who have shorted it suffer catastrophic losses.
But this is not always the case with short selling, so never assume that you will automatically be able to purchase back the stock at any given time. There has to be a market for the stock to be able to get out of the position early. There will need to be people selling the stock to be able to close.
Another factor that could cause a problem with closing your position early is the presence of a large number of buyers, including panic buyers, which is a common occurrence as more and more short sellers attempt to close their positions early, to avoid more significant losses as the stock continues to increase.
Another major risk of short selling is sudden news of a company getting acquired. For example, an acquisition that is a 40% premium over the current price of the stock, plus a $10 per share dividend, which can immediately put short sellers in a loss position that is likely to get worse. You should always understand the volatility of stock prices and account for it when making a decision as to whether or not you should short sell.
You also should be aware that the opportunity to buy and sell when the stock is on its way up or down is not always possible. There is always the risk that the share price could go through an instant reset or that the ask and bid prices can suddenly jump significantly. In some cases, the risk loss can rise with no limit. When this happens, an inexperienced trader could possibly lose everything. Most seasoned traders will understand this and are knowledgeable about how to limit or cover potential losses.
A final thing to consider when shorting a stock is that it is subject to its own types of rules. For example, you are unable to short penny stocks unless the last trade is at a slight increase. To be successful at short selling, you need to understand these rules and how the process works.
Short selling is not for the faint of heart. While good instincts and proper research can provide for a great opportunity for profit, there is also the potential for unlimited losses. Novice investors may find themselves overexposed and having to liquidate other assets to cover a major loss. Want to learn more about the ins and outs of short selling? Sign up for our online webinar, or download our free e-book today.
I’m out in Florida for the Daytona 500, and while I’ll be closely watching our RagingBull Ford Mustang and partaking in the festivities, I was able to sneak out for a bit and work on my trading game.
If you haven’t heard yet, February has been a spectacular month for me… especially with Weekly Windfalls. I locked in about $40,000 in real-money profits using that strategy alone, and I’m on a hot streak — and I don’t expect it to stop.
Of course, when traders caught wind of the success of Weekly Windfalls… they flooded my inbox with questions. So to help as many of you as possible, I decided to take on the challenge. The one question I kept noticing was: How can I start trading options?
I’m still a coach at heart, and my goal is to educate and guide you to options trading success!
And I get it — options can be intimidating at first.
But I know that with the right fundamentals under your belt, you’ll get the hang of things and be on your way leveraging your education into big bucks.
That said, I’d like to get back to basics and show you exactly what you need to know to start tapping into the massive potential in the market.
So today, I’d like to walk those of you still getting your feet wet through the ABCs of call options.
Cannabis stocks are sitting at multi-year lows… and one question small-cap momentum traders have on their mind is: When will the bounce come?
I’ll tell you one thing, trying to pick bottoms is a dangerous game… unless you know what you’re looking for. I can’t tell you how many times I’ve seen traders just buy a stock randomly because they think it’s undervalued… or make excuses that the stock is down too much.
They don’t have a clear-cut reason to enter the trade, yet they still do.
If you’re trying to find the bottom in the cannabis stocks… it’s going to be really tough. Instead, what you should be looking for are the ones that have catalysts and a chart pattern to go along with it.
That’s exactly what I did the other day, when I found a monster winner in New Age Beverage Corp. (NBEV). Today, I want to walk you through exactly how I traded NBEV and locked in $8,300.
On Monday, I let Jason Bond Picks clients know I had New Age Beverages (NBEV) on my radar. There were numerous reasons to trade the stock — multiple catalysts and a chart pattern that signaled NBEV could bounce.
New Age Beverages is a cannabis play, as the company is well known for its alternative beverages and emergence into the CBD-based drink business. While it’s not a pure pot play, it does get a boost when marijuana stocks do catch a pop.
In my weekly watchlist, I noted one of the catalysts I liked is New Age’s Marley brand — a selection of coffees and teas centered around Bob Marley’s values of natural living and authenticity.
NBEV’s Marley CBD line of drinks — the non-psychoactive portion of cannabis — is available in select states.
Not only that but I mentioned that pop culture icon Kendall Jenner (part of the Kardashian family) has become the “face” of NBEV.
If you know who the Jenners are… you probably know how massive their following is… and anything stock tied to them will move. Heck, back in 2018, her sister Kylie, tweeted about Snapchat (SNAP), and the stock cratered — losing more than $1B in market cap.
I figured Kendall Jenner could do the same with NBEV… but it’ll take some time for the masses to adopt NBEV. However, it was still a positive catalyst. There was another catalyst on the table for NBEV.
The stock is expected to report earnings on February 20, and it could be a catalyst runup play, as small-cap momentum traders may scoop up the penny stock ahead of the event. Especially after Canopy Growth (CGC) popped after its earnings announcement.
Sure, those catalysts are great and all… but I don’t buy stocks at random prices. I have to find an area of value, and chart patterns help with that.
Of course, NBEV was a beaten-down name… and it actually looked like it could continue lower because it was in a perpetual downtrend.
However, if you look closely at the Finviz chart above, you’ll notice there was a double bottom.
So what’s a double bottom?
Quite simply, it’s an area of support. Generally, traders view double bottoms as a sign the stock could rebound and continue higher.
If the stock fails to break support two times, more times than not, it could be on the cusp of a rip-your-face-off rally. Since there were multiple reasons to get into NBEV, all I had to do was be patient and trade the plan I developed and delivered to my Jason Bond Picks clients.
I noted I would look to buy shares around $1.90 to $2. However, I missed that by a tad… and when I saw shares trading above $2 (breaking above a recent resistance level), I pounced on the trade.
I alerted clients as I was entering the trade…
Of course, I had a target in sight… as I looked for a 10%+ winner.
Well, in just 35 minutes, the stock made the move, just as I suspected!
Just so you can see how easy the play was… you can see how I traded it on the intraday chart the other day.
That was good for an $8,300 winner in just 35 minutes! As you can see, I just placed my trade and let it work out, and the stock exploded. Now, I’ll still keep a close eye on NBEV because there’s just so much going on with it, and I actually re-entered the trade.
The key takeaway here is to spot the catalyst and find a pattern to go along with it. Now, keep in mind, I have multiple money-making patterns, and if you want to learn more about my bread-and-butter setups, click here to watch this exclusive training session.