Guide on How to Short a Stock: Using TD Ameritrade as an Example

Guide-on-How-to-Short-a-Stock-Using-TD-Ameritrade-as-an-Example

Stocks on the stock market move in two directions: up and down. When a stock’s price increases, sellers make money by selling at the higher price. That’s called buying and selling stock. However, there’s another way to trade: short selling.

If you know how to short a stock, you expand the ways in which you can make potentially money through day trading.

It might sound complicated, but once you know how to short a stock with online brokers such as TD Ameritrade (which I’ve used in the past), it becomes second nature. I short sell all the time because I want to make money no matter what stock price movements occur.

You can potentially do the same by learning how to take a short position.

What Is Short Selling?

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Trading platform concept with selector knob positioned on the word hold over black background and blue light. Concept image for illustration of stock market orders and simplicity. Via shutterstock.com

Before I explain short selling, let’s do a brief refresher course on investing in the stock market …

A long position is the opposite of a short position.

When you go long on a stock, you buy shares at a particular price point because you believe the stock price will increase. If the price moves in the direction you anticipated, you can sell your shares in that stock at the higher price point and make a profit.

A short position is the exact opposite. Short selling a stock means you’re betting the stock price will decrease over a specific period of time.

Learning how to short sell a stock takes practice, but it’s not as difficult (or as risky) as many people believe.

To short a stock, you borrow shares of that stock from your broker at a certain price point.

For example: Let’s say you think stock ABC will drop in price from its current price of $10. You might place a short sale order with your broker for 1,000 shares of ABC. The broker will then attempt to allocate those shares for your account and sell them.

Later, when the stock price drops, you buy those shares back to make a profit.

Let’s look at another example:

You believe that stock XYZ will drop in price in the future. It’s currently trading at $20 per share, so you issue a short sale order through your broker to sell 100 shares of XYZ.

The broker locates the necessary shares and sells them, putting $2,000 in your trading account. But remember, you borrowed those shares.

Later, you buy back the shares at a price point of $10, meaning that you only have to spend $1,000 of the $2,000 you pocketed. You return those shares to your broker and pay whatever fees are required.

That’s a simplistic view, but it’s the basic gist of how to short a stock.

Should You Try Short Selling?

Short selling isn’t for everyone, but it’s how some traders make great money during falling markets. If you know you can potentially profit from the stock market even when you expect a stock price to crash, you can often continue trading regardless of the market climate.

How to Short Stocks

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You’ll need a margin account to short stocks, which means that you’re able to borrow shares in a stock from your broker.

Margin trading is something I generally frown upon, but it’s useful when you want to short a stock.

Margin simply means that you’re buying or selling shares in a stock that you don’t own. That’s why many speculators are drawn to short selling.

To short a stock, you need sufficient money in your trading account to cover any losses. You have to know your risk tolerance — backward and forward — and understand that the stock could go in the opposite direction.

How to Short a Stock With Options

Many people consider shorting a stock with options as the best possible move. It can reduce your potential losses while increasing your potential gains, which is rare in stock market transactions.

Shorting a stock with options is called placing a put option.

The word “put” simply means that you’re betting the stock price will decrease.

A call option, on the other hand, relies on the stock price’s increase.

Options trading gives you the right to exercise a trade on or before the contract’s expiration. For example, if you have a put option on 100 shares of stock valued at $50, and the price drops to $40, you can exercise your put option and make money.

However, it’s called options trading because you have a choice. If the stock price movement doesn’t go your way, you can opt to not complete the contract. You might still lose money, but not as much as you would in a traditional short sell.

How to Short a Stock

I personally like using TD Ameritrade because you can learn how to short a stock through practice. So, I’ll give you a rundown on how to short a stock on TD Ameritrade as an example.  

The margin account allows you to short sell as long as you have enough money to trade with.

1. Enable Your Account for Margin Trading

Just simply opening an account with TD Ameritrade doesn’t mean you’re able to short sell. You have to go into your account options to enable this feature.

Then, TD Ameritrade will provide you with documentation and a form to sign showing that you acknowledge the risks of short selling.

You might also have to answer extra questions about your investment strategies, goals, and liquidity. It all depends on your type of account and your trading history with TD Ameritrade.

2. Enter Your Order to Sell Short

Once you’ve enabled your account for margin, you can enter an order to short sell a stock. It works the same as it would on any other platform. You have to specify that you’re planning to short this particular stock.

3. Account Minimum

You must have a minimum of $2,000 dollars available to trade with or short within a TD Ameritrade margin account. This requirement protects the broker in case your short sale goes in the wrong direction and you have to cover your losses.

4. Stocks That Can’t Be Traded By TDA

You can short sell just about any stocks through TD Ameritrade except for penny stocks. In other words, if you’re trading OTCBB stocks or the pink sheets, you won’t be able to short.

5. How Long It Takes to Enable Your Account for Short Sales

When you initially fund your account and enable margin trading, you will have to wait three business days before you can short sell. During that time, TDA might ask you for more information. They’re reviewing your account to make sure it qualifies for shorting a stock.

6. You Can’t Reserve Shares To Short

I often use my trading accounts to reserve shares for shorting later. TD Ameritrade doesn’t offer that option. If you put in a short sale order and no shares exist, the transaction simply won’t go through. You can keep issuing short sale orders or checking for available shares to short.

7. TD Ameritrade Short Selling Fees

Currently, the margin fees for TD Ameritrade are between 6.25 and 9 percent with a base rate of 7.75 percent. TDA’s stock commission is a flat $9.99.

How Do You Short a Stock on E-Trade or Robinhood?

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The process of shorting a stock on E-Trade is pretty much the same as shorting shares on TD Ameritrade. You have to enable your account for margin, and E-Trade must be able to find the shares you wish to short.

Robinhood, meanwhile, doesn’t allow you to short a stock. It’s a free trading platform with lots of limitations, as you can imagine, so you don’t want a Robinhood trading account if your intention is to learn how to short a stock.

Tips on How to Short a Stock

Learning how to short a stock takes time, but you can potentially shorten the learning curve by paying attention to the pros. Let’s look at some of the key factors to keep in mind when shorting stocks with TD Ameritrade and other brokers.

Timing Is Important

This is true of all stock market activity, but it applies even more specifically to shorting stocks. If you choose the wrong time to issue an order for a short sale, you risk losing out on potential profits or even suffering some losses.

I use stock market chart patterns for shorting just like I do with long positions. I also look for so-called “pump and dump” schemes that might allow me to profit from the downside after a pumped-up stock crashes.

A Tool For Your Strategy

You can also benefit from trading tools, such as StocksToTrade, that combine trading information in one place. For instance, you can use a trading tool to paper trade until you’re comfortable with short selling. It’s a great way to learn without putting your money on the line.

Be Careful

Shorting stocks comes with risks. So does going long. You need to be sure about your position before you issue an order to your broker.

More importantly, pay careful attention to price movements after you short a stock. If it starts to go in the wrong direction, cut your losses immediately. Don’t let your short position turn into a huge drain on your trading account.

Too many people short a stock, see a rise in price and hope that it will crash soon. That can happen, but you don’t want to bet on it. Maybe you haven’t heard about a recent announcement from the company that has risen its stock price for the foreseeable future. In that case, you’ll just continue to collect losses.

Learn With Pros

There are plenty of ways to gather knowledge about how to short a stock. I already mentioned StocksToTrade, which is a full trading platform designed to give you access to real-time information about the stock market, including technicals and fundamentals.

You can also join me on Profit.ly, which is like a stock market social media platform. We share our trades with one another, give each other advice, and comment on one another’s decision. It’s a highly active, engaged community of investors, and we’d love to have you.

Trading Challenge

If you’re serious about the stock market and its potential impact on your finances, join the Trading Challenge. It’s my way of nurturing the new generation of investors — hungry, eager people who have specific goals and dreams.

Through the Trading Challenge, you’ll get access to all my resources, trades, commentaries, webinars, and more. Plus, you’ll get the chance to learn from my millionaire students.

The Bottom Line

Learning how to short a stock can help make you a more prolific and profitable trader. I do it all the time because I know I can make money from it.

Of course, we all lose every now and again. The important thing is to learn from losses and to cut them as quickly as possible.

Do you know how to short a stock? What’s your best tip?

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