“Shorting” or short selling a stock is a confusing concept to grasp. But once you get it you’ll realize that being able to short sell a stock is mind-bogglingly exciting because you’re able to make money as the stock price goes down. It’s best to remember the old mantra “buy low, sell high,” although it’s more like “sell high, buy low.”

I’ll explain: When you short a stock you are selling off someone else’s shares as a loan that you’re agreeing to buy back, hopefully at a lower price. Whose shares? The stockholder who has been convinced by his broker to buy and hold. They’ll never even know the transaction took place and their broker is making commission on the secondary transaction on their long-term holdings. Bother you? It shouldn’t! The stockholder’s apathy is your opportunity to make some serious cash.

Let’s cover the basics: A short sell is how you enter the trade and a buy to cover is how you exit the trade. It is the reverse order of a typical buy and sell transaction.

AN EXAMPLE:

Let’s look at an example trade: You short sold 100 shares at $20.50. So that means that you took out a loan for $2,050.00. Once the stock fell to $19.00 you bought to cover the same 100 shares for $1,900, making a profit of $150.00.

Here’s the same information written in a different way:

Take out a loan for $2,050.00, pay back the loan at only $1,900.00 and you profit $150.00.

Yet another way:

Short sell 100 shares at $20.50, buy to cover 100 shares at $19.00 and you gain $150.00

And another:

(Short) sell high, buy (to cover) low

It’s pretty amazing that even when we’re in a bear market - you can make some real money. If you’re still a bit hazy here’s a real world analogy of what you’re doing when you short sell.