I have received a few questions about shorting stocks, the impacts and why I generally use short trades as part of my strategy! But perhaps the easier question would be how to actually do such a trade and it is fairly simple although there a few more restrictions and steps involved!
First off, being able to short generally cannot be done in any type of account so it is important to verify if you are allowed. Generally it is not possible to do such trades in retirement accounts in order to limit risk. While it might be possible to do so in cash accounts the general rule is to do such trades in margin accounts!
Once you know you can do the trade, the next step is to look at the volume on the stock you are shorting. Why? Simply because a broker cannot be short overall. It is fine if you want top be short but the broker will need to have the shares elsewhere or borrow the. You will of course be paying for the borrow but generally it will be paid back by the interest you will get on your sale. Remember you are selling a stock for cash right?
Then it is time to do your trade. It is quite easy, you must simply advise your broker that this is a short sell or “naked sell”. The broker will then proceed to the sell and borrow. If you want to short an illiquid stock, that can be a bit more complicated so your broker might have more problems borrowing the shares which would also mean it would be more expensive for you. Generally, stocks in the TSX60 or SP500 are easy to short!
After that, you can simply follow your trades and wait for the prices to go down hopefully. To exit the trade, you must simply buy the shares and you will be back to flat!
Like any other trade, you must be careful when shorting as you can lose and I always recommend setting a limit to ensure buyong back the stock if it increases too much!
In theory the loss is unlimited because if you short a stock that goes to $1 million, that will be your loss! But in practice, I don’t see these trades as being more risky because I still have that 20% limit!