How Does Short Selling Work?
As I told you yesterday, I’m “out of the office” for a couple days – but nothing can stop ME from MY passion, which is teaching you everything there is to know about how I trade VWAP.
I also told you yesterday that I did something I rarely ever do… I shorted the Invesco QQQ Trust (QQQ)!
I know, I know – usually I say “NEVER SHORT THE Qs, BLANCHE,” but this time the stars were truly aligned for a bearish-sided day trade.
In fact, I made you a short video about what happened with the Qs immediately after I went off the air Tuesday morning, and it’s wild:
>>Click here to watch my video message<<
In addition, I said that the upcoming slate of earnings reports could be the catalyst for a broad-market breather in the short term, and there’s a good chance that earnings optimism may already be priced into many of these high-flying stocks.
As such, today I want to give you a mini tutorial on how short selling works, and the Knowledge Bomb all bears should remember.
Knowledge Bomb of the Day
Today’s featured Knowledge Bomb is something you’ve likely heard me say more than once, if you watch me trade LIVE each morning: If you’re shorting, it should be short-lived.
Before we get into that, though, you need to understand basic market mechanics and what short sellers do.
The stock market is a Ponzi scheme, basically – most traders buy a stock at a certain price, then hope it goes higher so they can sell it to some other sucker and pocket the difference, right?
Shorting is the other side of the coin.
A short seller is hoping the stock goes LOWER, not higher, and they can make money on the way down – but not without facing some steep risk.
Here’s how the mechanics work, in a nutshell:
But let’s dive into a hypothetical example.
Let’s say the Virgin Galactic (SPCE) 1-minute VWAP is telling me to be on the bearish side of a day trade, and my buddy Spock owns a lot of SPCE shares.
Click here to… watch me… explain short selling like… William Shatner
- Borrow some of Spock’s SPCE shares
- Sell them at current market price (we’ll say $50, for a nice, round number) to someone who thinks the shares are going higher
- When SPCE falls to, say, $47, I’d then buy those shares back
- I’d deliver Spock’s borrowed shares and pocket the $3 difference in price
However, unlike simply buying shares outright, where your risk is limited to whatever you paid, selling a stock short is extremely risky and not for the faint of heart, which is why you need special clearance from your broker.
That’s because you’re on the hook to return those borrowed shares, no matter the price.
So if those SPCE shares went from $50 to $53, say – the wrong direction for a short seller – I’d either have to hold them and pray they drop again (and I’m not a bag holder), or swallow my losses and buy them back for more than what I sold.
Now, a $3 loss might not sound so bad, but consider that most short sellers don’t trade in 1-share increments; we’re talking thousands of shares at a time, so those dollars add up quickly.
And these days, with all the volatility we’re seeing, the shares you’re shorting could move even MORE against you in a day – if that theoretical SPCE trade jumped from $50 to $60, say, hoo boy!
This is why I always say, “If you’re shorting, it should be short-lived!“
That’s also why a lot of times you’ll see stocks that are heavily shorted enjoy a “short squeeze,” which is essentially a mad dash of short sellers looking to buy their borrowed shares back before losses get out of control.
The collective scramble to buy the shares back perpetuates even more buying, and it can fuel more upside than a stock without a lot of short activity might see.
The bottom line: Short selling is the greatest invention ever, but you have to know what you’re doing and risking, and you gotta be nimble like a ninja – in and out quick, like I was on the Qs Tuesday.
Talk to you tomorrow!
Kenny “The Warlock” Glick
Comments
3 responses to “How Does Short Selling Work?”
Leave a Reply
July 07 2021
What does shorting through options mean? I’d buy puts with hopes of selling them later at a profit? As opposed to selling puts with hopes of closing the trade by buying? Shorting has been a very scary proposition for me, but as I understand it, shorting through options at least defines maximum risk at $0 and not infinity.
Shorting and selling are basically interchangeable terms.
I have watched Kenny for hours now and read everything that looked like it would explain shorting stock but I still don’t know how it is set up. Is there someone who could write one as an example? How to enter it? Do you sell to open or buy to open or close? What the heck does it look like. I kind of understand the concept but an example of in and exit would be extremely helpful. I watched JD yesterday and bought on the upside but I want to learn to make money on the downside too. Thank You if you can direct me somewhere to learn this.