What is Short Selling?
Short selling is one of the easiest ways to profit from a falling share price. The profit/loss moves dollar-for-dollar with movements in the share price.
As you are aware an investor is able to buy a stock and make a profit when the share price rises in value. However not many people know that you can profit from the share price falling.
Short selling involves the sale of a share that the investor does not own with the view of buying it back at a cheaper price.
For an investor to sell shares that they do not own they must first borrow them from their broker. The broking firm will then enter into an arrangement to borrow the shares from an institution (e.g. Macquarie Bank). The shares are then given to the investor to sell with the intention of buying them back at a lower price in the future.
If the price falls as anticipated the investor is able to purchase the shares at a lower price and make a profit on the difference between the purchase and sale price. Once the shares have been bought back they are then delivered back to the institution.
Things to consider:
Margins: These are the costs required to hold the trade
Stock Lending charge: Fee to borrow the stock from the broker
Dividends: You must pay the lender of the stock any dividends, franking credits and rights declared during the course of the loan.
Brokerage: You need to take into consideration transaction costs.
Time Frame: Short selling is generally a short term trading strategies.
Stay tuned for part two; When to short and Stop loss.