In part one of this post (nicknamed Shorting stocks for dummies), I wrote the first five things you need to know in 10 things to know in shorting stocks. Being a beginner investing in the stock market can be dangerous without the knowledge behind the science.
Here are the other five things to know when shorting stocks.
6. Margin Calls – This is probably the scariest thing about owning a short position in any company.If the stock you’ve decided to short moves in the wrong way (stock price rises), your broker will insist that you do one of two things. One, deposit more money into your account, enough to cover the purchase price of the stock at the current price. The other choice is that your broker will insist that you sell some of your long positions to cover the margin call or they will do it for you in their own way.
7. Early Sale – If the original owner of the shares that you borrowed decides to that they want to sell the stock, you must replace it — either by finding other shares through your broker or buying it on the open market. Remember all you did originally was “borrow” the shares.
8. Short Squeeze – If you’re new to the stock market then this is a term that you might not be familiar with. It’s a term that is used quite often on Wall Street. A short squeeze is when the price of the stock jumps up in value quickly, causing short traders to “cover” their positions. Which means that they have to buy shares to cover the ones that they borrowed. This typically causes higher prices, which prompts more people to sell and to take profits. This is something that you may never want to get caught in the middle of because of the ferocity of the situation as well as get quite expensive.
9. Properly Covering You Position – You may not even realize it, but you can have a short and a long position at the same time. When you go to “cover” your short position, you need to tell your broker clearly that the shares you’re buying are to cover your short position. If you just buy the share while still having a short position, you’ll have conflicting positions. Many times people are in a rush to cover their position, that they may not even realize their mistake of overlooking their selection, especially online traders.
10. Dividends And Taxes – If you have borrowed and shorted a dividend-paying stock, you will receive the dividends, but you, in turn, must pay the original owner the value of those dividends. Also, should you hold a short position for more than one year, well, tough luck — the IRS still treats capital gains as short-term gains. Ah, Uncle Sam is always reliable!
I hope these ten things I’ve given to you will help you in your trading. If you are new to the stock market, then it’s wise to stay away from shorting stocks until you learned more of the basics.
© 2011 Beginner Investing
Awesome news. We’ve been looking for this info.
Twitter: joannegreco777
says:
Hi Rob, Thanks for the question. When you borrow the stocks to short it, the person (or broker) you borrowed them from is the beneficiary of the dividend payout. If you did your due diligence you would worry about the dividend payout since your profit will be in the poor performance of the stock you shorted. If you think about it, you did only “borrow” them from the owner of the stock.
Excellent article but kindly help with this one point — if we short a divident paying stock, how do we pay the divident to the person we borrowed the stock from, since we have sold the stock when we shorted, so we will not be getting the divident from the stock itself, and so will we have to come up with that money ourselves and give this money to the broker( E-trade, etc.) ? Kindly explain this point.