Short Selling – Its Meaning in the Trade of Stocks and Mortgages

Short Selling

 

In recent years, short sales have become part of daily vernacular. For many people they know it to be a process where some item, usually a house, is sold for much less than what is owed on it.

After the Great Recession of 2008, many people became familiar with short selling as a means to getting out from under a very high loan that the value of the home could not come close to covering. It was a good option to take rather than go the route of bankruptcy. There are other meanings to short selling, however.

For many investors in stocks, the meaning is different. To “go short” an investor will look at his or her portfolio and then take a look at what stocks are on the market and on the decline. When an investor senses that a particular stock is about to go down, he or she can benefit from the impending decline by going short.

In this scenario, the stock investor will buy shares of that stock with borrowed money, and hold onto it for just enough time to see the decline begin. When this happens, the investor will sell the stocks and buy them back again at the lower price. It is a good strategy for an investing professional to use when certain stocks become over-inflated.Short Selling

Again, during the crash of 2008, much of the downfall came from the speculation on individuals defaulting on mortgages which happened by the millions. Many of those defaults were insured by market valuations, but when the market crashed so did everything else including the default swaps as they were termed which brought down huge banking institutions. During this time, short selling would have been a good strategy to implement ahead of the crash so as to mitigate the many losses involved.

How Going Short Works

The way short selling works is that an investor buys stocks with the help of a broker. If the investor wants, he or she can set up a cash account. The broker will take the cash, charge a fee, and buy the stocks desired by his client. If the investor chooses to buy “on the margin” with the account he or she sets up, something different can happen.

If the investor is anticipating a drop in value, the broker can loan him or her a share of stocks equal to the value of the item. When the value of it does drop, the investor can close the short by purchasing the stocks back, but at an even lower price thereby making a profit on the difference.

It can be a complex and confusing process and does come with some risk. However, it is very simple to have an investor of any level of experience make good profits off of short selling various stocks. Obviously, the investor simply has to know enough about various markets and commodities to know if and when the timing for short selling is best.