I got this text from a client’s kid, “What’s a short sale?”

Here’s a step-by-step example:

Let’s say you believe the price of a stock will go down. Today, the price is $10 and you believe it will drop to $5.

Step 1: To make money on this stock, you borrow 100 shares of it from your broker (Schwab, Fidelity, Vanguard, JPMorgan, etc). Once you do this, you have 100 shares of the stock in your account, with a price of $10 per share for a total account value of $1,000.

Step 2: You immediately sell all 100 shares. Now, $1,000 of cash sits in your brokerage account. Keep in mind, you still owe your broker the 100 shares you borrowed.

Step 3: One month later, the price of the stock falls to $5. You use $500 of the cash in your account to buy back the 100 shares of stock.

Step 4: Now that the 100 shares are back in your account, you can transfer all 100 shares back to your broker. Your broker now has the 100 shares you originally borrowed and you’ve got $500 cash sitting in your brokerage account. That’s $500 you didn’t have before you borrowed the shares.

That’s a short sale. Borrow stock, immediately sell it at a high price, buy it back at a lower price (hopefully), pay back the shares you borrowed, make a profit.

What happens if the stock price goes up? Nothing good.

With short sales, weigh the tradeoffs very carefully. Very, very carefully.

Disclaimer: For information purposes only and should not be interpreted as legal, tax or financial advice. Always consult your CPA/tax advisor/attorney (or reach out to us;) to discuss your specific situation. Past performance is no guarantee of future results.