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Selling it Short - The Day Traders' Favorite Game
Selling it Short - The Day Traders' Favorite GameOne of the most common strategies used by day traders is short selling - the borrowing and selling of shares in the hope of price falls during the day in which the trader buys back the stocks he borrowed at a lower price. Short sales are done by day traders and institutional investors - as it is a perfectly legal way to trade stocks. Shorting trades may last from a few seconds to several hours, but always, the trader doing the short must return the borrowed shares before the trading day ends or when the broker calls these in.To illustrate how the scheme works, let's take as an example Yahoo, which was quite volatile during the days when the Microsoft offer was on the table. A trader connected to a large brokerage firm may borrow 10,000 Yahoo stocks from his brokerage firm and short sells it at the current market price of, say, $20/share. If during the day, the share prices drops to $19/share and the trader buy back at that price, he easily nets $10,000 less transaction costs. If the price doesn't move during the day, the trader loses nothing but the transaction costs. However, if the price goes up and doesn't return to $20 or go lower, the trader ends up a loser in that trade.It's is really a gamble and a high-risk investing method. But day traders don't simply pick out any stock at random for short selling. They sniff out the companies, check out the SEC filings and compare these to the flattering press releases and decide which one is overvalued at its current price. It's basically finding some crap stocks that are likely to go down during the day and betting your money that it will. Several problems are associated with short sales. First is availability of stocks to borrow. Brokers, which earn from lending activities through commissions, may not have shares to lend on a specific stock, especially if the company float is limited. Generally, you have better chances if you're connected to large brokerage firms that manage many large accounts from which they could borrow stocks to lend to you. This brings us to another negative thing about shorts. The owner of the accounts from which the broker took the shares you borrowed, or evens the broker himself, can at any time call the shares in. That means you would have to return the shares, whether you're losing or winning the game. But the cruelty of it is the fact that panicking brokers will mostly likely call in the stocks when you are at a losing position.Even if it is perfectly legal, the fact that you are trading on borrowed stocks is quite deceitful. The actual owners of the shares are not aware of the borrowing of their own stocks, though they know that it's a common practice. While investors suffer neither losses nor gains, shorting shares of unknowing owners is frowned upon on by some people, especially conservative folks who think that betting stocks to go down is simply evil. These are just some of the issues on short sales that are commonly debated on threads and forums. But just a word of advice: don't believe on the myths at the other end of the spectrum that shortens are evil conspirators out to put good companies down - it simply isn't true as shorting wouldn't normally affect firms with good fundamentals. The bottom line whether you're trading short or long, do the same with caution and due diligence.
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