… or Shorting Stocks For Dummies (Because they don’t have a book out for it yet)

If you’re a beginner investing in the stock market and trading stocks, there’s probably many terms and phrases that you’re not familiar with.  One of the many terms that you’ve heard by now is “shorting stocks“. The idea behind it is that an investor expects a company’s stock to go down in value and he/she will invest in it accordingly.

Typically when you buy shares of a company, you buy at a low price and then sell it at a higher price than what you paid. In shorting a stock you “borrow the share from a broker and sell them at a certain price and at a later time, you buy those those shares at a lower price to return to the broker. Of course, there is more to it that just this simple explanation of the process.

1. Risk – There is more risk involved in shorting a stock then there is in buying a stock to go up (long) in value. If you borrow a stock while it’s trading at $20 and it runs up to $100, then you’re out $80 a share. Unlike when you “go long”, you can only lose $20 a share as it falls to $0.

2. Locating A Stock – In the past year there has been a law passed that prevents someone from borrowing stock if you can not locate any available shares. In recent years, a trader would borrow shares that no one had and wait for the price to drop to buy the covering shares, but how can he buy them if no one had any? In this case it was referred to “naked shorts”.

3. Outstanding Short Position – The number of shares of a company held short, it is measured in absolute numbers, and/or a percentage of the float of the stock. Usually if the position is more than 10%-20% of a company’s total shares, it means that the bad news has already been factored into the stock’s price. If you find a company with a large short position, you need to avoid it all together.

4. – Margin Account – To be allowed to short stocks you will need to open what is referred to as a margin account. A margin account is where the funds will come from for you to borrow the stock. Take into consideration that you will be charged from your broker a “broker loan rate” (fee) based on the price of the stock. Also you will not get any interest on the margin account or have it rolled over into a money market account on the funds not being used.

5. Liquidity – Just like I said about an outstanding short position, if a company has too many share outstanding (liquidity) you need to avoid the stock. A stock that is not highly liquid should not be shorted. In this case you may find yourself stuck in the stock where you may not be able quickly liquidate your position.

In a future post, I’ll discuss more stock shorting tips for you.

Here is part two of 10 Things To Know About Shorting Stocks.

Reader Question:
To our readers who invest in the stock market, what’s your advice for beginners who want to to learn how to short stocks?

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Just like when you hear that you haven’t taken a loss in a stock until you sell out of your position, the same goes for your profits. You didn’t make anything until you have sold the stocks.

After the DOW made some major drops and looked like it it had bottomed, I started to build up a position in some stocks that I’ve been watching for some time and know that they were solid companies with good fundamentals. The stocks gained in value by about 25% and from my experience, I sold out of about 50% to 75% of those positions. What I didn’t expect was that the stocks weren’t done gaining value. The DOW pretty much leveled off, but the companies that I invested in had some more momentum in them. I missed out on an extra 10% to 12% of gains that I could have had if I just hung in there and waited.

My point is that yes I could have made more money than I already did, but I could have lost a good portion of those gains too if the stocks fell. I’m just as happy with the 25%-30% gains since they are now in my account as cash. There’s a saying that I’ve heard Cramer say many times and I agree with him. Bulls make money, bears make money and hogs get slaughtered. As long as you continue to make money in the stock market, you’ll be able to continue trading and investing in stocks.

Being able to sell when you’re up is easy as long as you don’t get greedy. I’ve spoke about it before and I will talk about it again. Be happy with the gains you made instead of getting frustrated over the money you could have. The same thing goes when you’re looking at a stock to invest in and before you get the chance to build a position in the company, it makes a big jump in value. You missed the opportunity and there will always be another one as long as you are looking for them. I watched too many people try to “chase” a stock up only to get in it right before other trader start taking their profits.

Don’t get yourself bent out of shape if you miss a ride up on a stock and don’t get “hog-like” by staying in the stock too long. Following these rules will help make you a better investor or trader.

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During the time that I was working full-time, I didn’t have time to sit and watch the tickers during the day’s trading hours. I would sit home at night and catch up on the day’s news and do research on the stocks that I was interested in buying. If there were stocks that I decided to buy, I would set up a limit buy order, which was typically lower than the stock’s closing price. The next day after work I would come home to see how my trades went.

After I stopped working for someone else, I started spending more time during the day tracking the activities of the day’s events on Wall Street. I would be able to keep closer tabs on what was going on and react when I thought the time was right and the opportunity was good. I also started to take Jim Cramer, and his stock investing tips, more seriously.

I started to notice that my gains weren’t as good as they were when I was working. I wondered what was the problem. I took a little while for me to realize I had changed my trading strategy, without meaning to.  Since I was able to watch the stock market more closely, I was also exposed to the constant fluctuation of the share prices.

For example, let’s say I was researching stock XYZ  and it had a share price at the close of the day of $20.65. I would set the limit order to buy at $20 per share. Since I was at work I never really saw how the price reacted throughout the day. Once the price dropped to my target, the sale would trigger at the point and I would have my shares at the desired price.

When I was home and watching throughout the day, I started to react to the minute by minute moves. Let’s use the same example of stock XYZ. If the price opened up at $21.05 and then for the first hour or so of trading it moved up to $21.35, I would think that others had seen the same good numbers on XYZ and were buying up as quick as possible. I would set a limit order at $21.25 just to grab it a little lower than where it was. Wouldn’t you know that after the stock climbed, it started to descend. It would go down below where it closed the day before and in some cases, go below the original limit order price of $20 per share.

What I was doing is what I refer to as chasing a stock. Chasing a stock will do nothing for you but make you lose profits and wait longer for a turn-a-run after you’re in the hole by a couple of percentage points. Granted, the stock I would get into would go up well above the $25 dollar range and I would still make a profit, but like I said earlier, my profits weren’t as big as before.

If you want to be successful in stock trading, you need to understand your actions first. Many people don’t realize that the individual’s emotional state will totally effect the profitability of your portfolio.

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I can sit here and tell you all about my positive and profitable experiences, but how much are you really going to learn by an experience where everything was done right?Those posts, and we have them here, have their place. They inspire and encourage but they don’t teach. That’s why on this site you will see both the positive and negative trades, but more of them will be the ones where I made mistakes and learned a huge lesson in the process.

I’ve said it before and believe me I’ll say it again and again, your emotions have no place in any of your trading decisions. If you think that people make it rich by playing hunches or a vibe that they had, I will tell you one of two things. Either they were very lucky or they are lying through their teeth. No matter what the reason, they took a very big risk.

In 2007 I was trading stocks in Sirius Satellite Radio and I was ahead several thousand dollars. Investors were coming into the stock and I was doing great. In the summer the announcement was made that they were going to merge with XM Satellite Radio to form one company and reduce expenses as well as increase revenue.

What I should have done there was to take my “marbles” and go home, but I figured this was the payday that I was waiting for. I’ve been a big fan of Howard Stern and subscribe to Sirius because of him. That’s where my emotions should have stayed.

Instead I took a position in the company after it dropped from where I sold out of all my shares. When the stock dropped some more because of the FCC delays on allowing the merger to go through, I bought more. At this point I was down 20% from cost basis.
After reading about all the hoopla that was circling the companies, I felt that this was all going to blow over and the stock would blast off. When the stock lost another 15% I had a feeling that this was just some sort of typical game that was being played during a long-dragged down fight between the FCC and the two companies.

At this point I lost all the profits that I made earlier in the year on the stock. I figured that I’ll make it all up once the deal was approved. I decided to buy as the stock fell. Not once, not twice, but three time.  Right after that third time, I realized this was a trade that was controlling me, not the other way around.

I was about to start selling when the news was released that the Department of Justice approved the two companies to merge. The price jumped over 33% and I was back in the green again with the trade. At that point I didn’t think anything was going to stop this from going through and I was going to hit it big.

My emotions got in the way (again) as I watched the politicians play their game in trying to destroy the companies and dragged their feet as we waited for the FCC’s word on the merger.

By the time the approval came from the FCC, the two companies had lost millions of dollars each and was expecting to lose more over the next two quarters. I held on for whatever rallies came and started to trim my position in the stock. Unfortunately by the time I got out of the stock I was down over 35%.

If you’re new to the stock market, try your hand at the free fantasy stock market out there. It might give you the experience you need without losing any money. If I had listened to my brain instead of my feelings, I would have gotten out right after the DOJ’s approval came out. I wouldn’t have made that much money, but I also wouldn’t have lost as much as I did.It’s a lesson I learned the hard way. Keep your emotions out of the stock trade. It’s the only was you will survive.

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It’s no different than a child who is growing up and learning about life. When you are new to something, it’s expected that you will make mistakes. The important thing about it is that you learn from those mistakes and move forward. One quote that I keep in mind every time I trade stocks is “Knowledge Is Power”. Knowledge is one thing that no one can take away from you. Once you know it, it’s a tool to be used again and again,  throughout your life.

What you do after you’ve made a mistake is just as important as learning from that mistake.

Let me tell you about my very first trade. I was trying to place an order with TD Ameritrade for 1000 share of a beverage company that had a earnings report coming out the following day. After I clicked on the confirm button, I waited for the transaction to go though. About a minute later the screen change and informed me that my order “timed out”. I didn’t know what had happened. My mentor and I decided that I should place the order again. I went through the steps again and wait for the confirmation, but again the order “timed out”. I went to my portfolio page and according to the page,  my balance was zero. Needless to say I went ahead and for the third time, placed the order, only to have it time out one more time.

My first mistake was that I didn’t call the customer service number to check out what the status was after the first attempt. The second mistake was not to call customer service when it happened again.

One would think that after three attempts to place the order, I would have wised up and called. Yes, you would think that but I proceeded to do it again for the fourth time. When it timed out on that attempt, I finally called to find out what had happened.

The customer service representative informed me that each time that I placed the order it was filled. So now I was the proud owner of 4000 shares of a company that was to be a speculative play. I had 50% of my portfolio money tied up in a stock that if it had a bad earnings report, I could be hit hard since the report wasn’t due to come out until after the close of the day.

The next day I watched the streamer all day long, waiting to see the action throughout the day.

At 3:50pm, ten minutes before the close of the trading day I was up $1 per share. If you do the math, I was up $4000 dollars. I had a bad feeling though and considered dumping the shares and call it a good day, but I didn’t do that.Another mistake. I didn’t listen to my gut instinct. Instead I listened to the advice of my mentor and made the decision to ride it out.

Do I really need to tell you what happened to me in the next 17 hours while I waited for the stock market to open up?

The report came out at 4:05pm and the company missed the street’s (Wall Street analysts) estimates by $0.04. Not only that,  they also stated that their guidance for the next quarter was grim. I watched as the stock price dropped down to my cost basis and continued to go south from there. By the time I was able to sell out of my position, I had lost $12,000.

That was the most expensive lesson I have learned up to this day. I realized that not only did I make one mistake, I made five in in a twenty-six hour period involving the same stock. The reason that I say the “lesson I have learned” is because I’ve never made any of those mistakes again. It’s been years since that trade, but it’s the one I will always remember.

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There are many words and terms used that you may be unfamiliar with. Here are the meanings of some

This post will cover many of the words and terms that are used when trading stocks. These are only a few but I’ll cover more in upcoming posts.

Cost Basis:
Cost basis is referring to what you pay for the stock. If you were to buy 100 shares at $30 per share then your cost basis would be $30. Now if you go ahead and by another 100 shares as the price drops to $25 per share, your new cost basis would be $27.50 per share (100 X $30)+(100 X $27.50)=$5750.00/200 = $27.50

Incrementally:
When you start to build a position in a particular company, you don’t go ahead and buy all your shares at once. Stock prices rise and fall and the time and if you purchase all your share at on price then the value falls you either have to sell at a loss or hold until the price comes back up in value. Buying incrementally will also help you lower your cost basis.

Diversification:
As you build your portfolio you need to keep in mind that you can’t just buy stocks in one sector. If you were to buy stocks in three companies and all of them were in the energy sector, you would lose a lot of your capital (cash) on a day that the sector took a big loss because the price of oil dropped. The idea is to not put all your eggs (investments) in one basket. What you need to do is have your investments spread out over different sectors. You also need to be aware what sectors effect other sectors (more of that in another post).

Fundamentals:
When researching any stock you need to look at what is referred to as fundamentals. It’s basically the financial information that can be found in a company’s earnings report or annual statements. An earnings report is information that the company puts out quarterly to inform their shareholders of the condition of the company as well as any future guidance.

Long/Short:
At times you will hear a stock analyst state they “long a stock” or “short a stock”. When they refer to “long”, they mean that they are invested in that particular stock for it to go up in value. If they state that they “short” a stock, they expect the company’s stock will go down in value because of one of numerous reason and they’re investing in it to go down in value.

Dividends:
Some companies will give their shareholders a cash payment. This is usually done on a quarterly basis and is given to shareholders that are listed on record at the time of payment.

Yield:
The yield is calculated by figuring the annual dividend divided by the stock price. The yield is referred to in percentage terms such as 5%.

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