Question on Shorting Stocks

[CarreraS2]

I understand how it works basically, but have never done it.

You borrow the stock from a brokerage and sell it.

Then if it declines, you buy the stock on the open market and give it to the brokerage to pay them back.

E.g. You borrow 100 shares of TOL at $100 per in August. You sell those borrowed shares for $10,000.

In November the stock drops to $30. You buy 100 shares for $3,000 on the open market, and give them back to your broker.

So you've made $7,000.

Q: Are there any time limits? i.e., is there a limit on the time that I would have to replace the borrowed shares? If so, does that time limit vary, and is there a normal limit?

Seems it would be bad if your timing wasn't exactly right, the stock hasn't gone down yet, but you are forced to buy and replace because of a time limit.

Q: Are there typically extraordinary costs involved with doing that? Seems like there would be borrowing type costs, since you are borrowing the shares and cashing them out. What do these costs average?

[Rob Channell]

You may want to check out options for a safer alternative. You buy the option to buy or sell a certain stock on a certain day at a certain price. If your guess is good you make some money. If you guess wrong, the option expires and you are limited in losses to the cost of the option and not the cost difference of the entire stock price change.

I bought and sold a few a while back in one of the standard online investment accounts. It was too much work to track options and individual stocks so I moved back into mutual/index funds.

[cowtown]

Time limits: no, but they can get "called" meaning you've got to get out now.

Also remember that you have to sell on an uptick. If the thing just keeps plummeting, you can't get out.

[turbo6bar]

Yup, you might want to try options. You'll control more stock, have less downside, but you'll also sacrifice some upside for that security.

Anybody trade stock options?

[jyl]

One thing to watch is the short interest on the stock. If the short interest is high - say, 20% or more of the float and/or 4 or more days to cover - that indicates it is a "crowded short", meaning that lots of investors are shorting the stock.

The danger is that there is some "good" news, and many of those short have to cover, setting off a scramble to buy shares. The news might look bad on the surface (losing money, revenue decline, etc), but just because it wasn't as bad as investors were fearing, gets counted as "good". Since the longs presumably aren't that interested in selling - there's just been good news, after all - the price can jump 10% or more overnight, inflicting losses on those shorting the stock.

In fact, I usually use a high short interest as one sign that I should be looking at owning the stock long.

Another thing to consider is that a losing long position naturally gets smaller, and hurts you less with each successive 1% drop. A losing short position naturally gets larger, and hurts you more with each successive 1% increase.