By Hrishikesh Menon. Edited by Arjun Chandrasekar.
Overview
Short selling a stock is the opposite of buying a stock. It is when you borrow shares of a certain stock from a broker with the prediction that the stock will go down. Once it is down, you are expected to buy back those shares at a lower price and the difference between the entry price and exit price is the profit.
What is Short Selling AKA ‘Shorting’?
Like stated above, short selling is when you borrow shares of a certain stock from a broker with the prediction that the stock will drop. For example: John predicts that stock ABC will go down from $100 to about $90. John puts in a short position of 10 shares at $100 and just as he predicted the price dropped to $90 and John bought back the 10 shares he shorted leaving him with a $100 profit.
Margin Accounts
Since short selling is done through a broker, unlike buying a stock, shorting cannot be done through a regular cash account. The trader must apply for a margin account if they want to be able to short stocks. A margin account is where the principal amount for trading is the trader’s cash plus some borrowed cash from their broker. Shorting can only be done using the cash borrowed from the broker. The broker will require the trader to uphold a certain amount of funds in their margin account. For example: John applies for a margin account, puts in $15,000 and borrows $10,000 from his broker. As a guarantee for the borrowed cash, the broker will require John to keep the account value at or above $25,000. If John makes a bad trade and the value drops below the required amount, John will receive a margin call. A margin call indicates to the trader that the account value has decreased below the required amount and the trader must either deposit more cash into the account or sell off assets held in the account.
Days to Cover
Days to cover is an indicator of the short interest in a company. Short interest is simply the metric which calculates the shorting volume of a stock. Days to cover measures the amount of expected days in which a trader should close out a short position on the underlying stock. Higher number of days to cover indicates a more bearish opinion of traders on the underlying stock and lower number of days to cover indicates a more bullish opinion.
