By Andrew Horowitz

In the last episode, we discussed the basics of shorting stocks and learned a real-life example of what it means to short sell a stock... or to "go short" on a stock.  Before that, I described what inverse ETFs are and how those funds act like short-sale positions in protection or hedges for a Winning Investor's portfolio, particularly during a downward move in the market.  Be sure to listen to these podcasts before learning exactly how you can short sell a stock or buy an inverse ETF, which is the focus of this episode.

A Recap of Short Selling

Let's start first with shorting an individual stock.

Remember, we said that "shorting" a stock is in many ways the "reverse" of buying a stock.  As investors buying a stock, we want to "buy low and sell high."  However, when we want to short a stock, we "sell high and buy low" later.

So how is it that you can do this?

Remember back from our earlier episodes where we discussed how favorable ratios and fundamental analysis can help us select a strong stock that is poised to rise in value in the future?  Let's think about the opposite of that.  Perhaps our analysis gives us a company with poor fundamentals that we expect to lose money or get into some type of economic hardship in the future.  In other words, we would not want to invest in that stock, but we might actually feel so strongly that we are correct the stock price is going to go down that we would want to short the stock to make money.

Remember, when you short sell a stock, you will have to buy it back later in the future, and you hope the price goes down so you can buy the stock back cheaper.  However, if the price of the stock goes up, you will be forced to buy the stock at a higher price than you short-sold it for and you will have to pay your broker the difference, which means you'll lose money--.in the same way you’d lose money if you bought a stock, the price went down, and then you sold it for a loss. 
Remember, when you short sell a stock, you will have to buy it back later in the future, and you hope the price goes down so you can buy the stock back cheaper.

How to Short Sell a Stock

To sell a stock short, you need to have a margin account so that you can borrow shares in the first place.  Usually, this takes a little more paperwork for you and sometimes you might have to prove that you have more than a few years investment experience so that your broker knows you are aware of the risks of shorting a stock.

Once you have met the requirements with your broker, you can either call your broker to tell him you want to short a particular stock and how many shares you wish to borrow. There are no magic hoops to jump through, and you don't have to do anything except make your intention known to your broker and he or she will take care of you from there.  Because you're borrowing the shares, you'll have to pay a small interest fee for the duration of time it takes for you to return the stock.

How to Short Sell Online

If you have an online broker like TD Ameritrade, Schwab, Scott-Trade, or any other online trading account where you don't have a broker, then it can be easier to short a stock because you won't have to tell anyone what you're planning to do.

You'll still have to fill out the paperwork in advance and make sure you are cleared to short, but to put on a short-sale position, you would just click the "Short Sale" or "Sell Short" button, which is almost always next to the "Buy" button.  If your broker offers a practice account, you may want to try your first short-sale in this practice account to get a feel for how to short a stock --it really isn't much different than buying a stock which you are familiar with anyway.

How Inverse ETFs are Like Short Selling

If you can't short a stock, or don't feel comfortable "being short," then you can buy almost any inverse exchange-traded fund like we discussed in Episode 17.

For example, if you thought the S&P 500 was going to decline over the next month, you could buy the fund with symbol "SH" which is a standard "inverse" fund.  I would advise you to be careful anytime you see "2x" or "leveraged" inverse fund, and not buy those until you have experience either shorting stock or buying regular inverse ETFs.

Remember that shorting stock, or buying inverse ETFs can hedge your portfolio when the stock market goes down.  We will discuss why we would want to hedge and what that means in a future episode.

I wouldn't be doing my job if I didn't tell you to consult your broker before putting on a short-sale position or to read the guide that comes with your online trading platform to know exactly how to carry out the position the right way.

Keep with us as we discuss even more ways to become a winning investor in our next podcast! If there’s a question you’d really like to ask, just email me at winninginvestor@quickanddirtytips.com or call 206-338-0836. That’s 206-338-0836 and maybe your question will appear on the show.

And if you like the show, tell a friend or leave a review on iTunes. Until next time, this is Andrew Horowitz with The Winning Investor’s Quick and Dirty Tips for Beating the Market wishing you all the best on your quest to investment success.