Stock Market for Beginners

I’m sure you’ve heard the terms “long” and “short” thrown around in investing jargon. Many of you may have always wondered what that meant. Well, going long on a stock means that you are purchasing the stock expecting it to go up whereupon you can sell the stock for a profit. This is the traditional form of investing that most people are used to. Going short on a stock means that you are borrowing and selling the stock expecting it to go down whereupon you can buy the stock back and return it for a profit. In essence, going short on a stock is the same thing as going long, except you’re doing it in the opposite order.

Let’s take an example to illustrate this point. Let’s say that you think stock XYZ is going to fall in price for some reason, so you decide to short 5 shares of XYZ at $10 each. Here are the steps involved in initiating a short position:

1. You borrow 5 shares of XYZ from the broker.
2. You sell those 5 shares of XYZ at $10 each and receive $50.

You now have $50 in your pocket and owe 5 shares of XYZ.

Now let’s say that a week later, XYZ has indeed fallen to say $5. Here are the steps to cover (or buy back the stock to neutralize your short position) your position on XYZ:

1. You buy 5 shares of XYZ at $5 each at a cost of $25.
2. You return those 5 shares of XYZ to the broker.

You now have closed your position and have come out with a profit of $50 - $25 = $25.

Stock Investing Basics

• In most cases, brokers will require you to fill out paperwork in order to give you the ability to short stocks.
• The process of shorting does not require you to actually perform the two steps listed. There is typically an option in the trading form called “short” where the broker automatically borrows and sells for you.
• The process of covering does not require you to actually perform the two steps listed. There is typically an option in the trading form called “cover” where the broker automatically buys and returns for you.

Further Reading

• Motley Fool FAQ - Shorting Stocks
• About.com: The Basics of Shorting Stocks
• Wikipedia - Short (finance)

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