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In a short sale, the trader or investor is selling stock that the investor or trader does not own in the expectation that the stock price will drop. Many people have never understood the concept of selling short. In effect, the short seller is selling a stock that he or she doesn't own in anticipation of a decrease in the price of that stock. The hope is that if the stock goes down, the seller will be able to replace the shares at a lower price and the price differential will be the profit. Conversely, if the price increases, the short seller will be forced to pay up for the stock, thus incurring a loss. The average investor does not often sell short because of an inbred belief that it is wrong to sell something you don't own. Short sellers theoretically face unlimited loss because there is no limit to how high a stock price can go, whereas a long buyer can never lose more than the purchase price. If you short (sell) a stock at 10 and the price rises to over 100, you will lose more than 90 points, but if you went long (bought) the stock at 10 and it went to zero, all you lost was 10 points. |
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Only a robber baron like Jay Gould could finagle himself into a position where he shorted (sold) more shares than were available for repurchase in the market in an attempt to buy control of Commodore Vanderbilt's railroad. Gould was forced to buy the last share from the commodore at rich, arterial blood prices. Hence, the ditty that "he who sells what isn't hisen, must deliver or go to prison." |
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The professional trader is far more sophisticated than the average investor and knows that selling short is just as legitimate a trading strategy as going long. In order to make money trading, you must sell a stock for more than you bought it. It doesn't matter whether you buy or sell (short) the stock first, as long as you wind up selling it for more than it cost. |
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Often, when the price of a stock rises, it increases slowly due to incremental profit taking. When a stock price decreases, however, it often drops quickly in a very pronounced and recognizable manner. Traders want to be positioned to take advantage of a drop in the price of a stock because there are fewer people able to take advantage of the opportunity. |
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