What is short selling and how do you sell stocks short?

Quite simply, when you sell a stock short, you reverse the usual investment sequence. Typically, one buys an investment and sells it later -- hopefully at a higher price. But selling short reverses this process -- one sells the stock first, then buys it later, hopefully at a lower price.

• Going long:  Buy XYZ at $20, sell it at $30 and make $10 profit
• Going short: Sell short XYZ at $20, buy it at $10 and make $10 profit

“But wait,” you might ask, “How can you sell something that you don’t own?”

The answer is what you might expect: You borrow it. Selling a stock short involves first borrowing the shares from the brokerage firm where you have your account.

Because short selling requires borrowing stock, it must be done in a margin account. A margin account also allows you to borrow money from the broker for long purchases. Opening a margin account is a fairly simple process: You first open a regular brokerage account, then you complete margin paperwork that allows you to trade with borrowed money or sell stocks short. After signing the “margin agreement” and making a deposit, you can begin short selling.

• Here you can find some of the best brokers

Hold on a moment though -- before doing any trading you need to lay out your plan. And the plan will be based on research and analysis that gives you a reasonable expectation that your short sale will be profitable. More on that in a moment.

Once you have your short strategy laid out, and you’ve targeted a stock to sell short, you must first learn if that stock can be borrowed. Your broker will have an “availability list” of all shortable stocks and the number of shares available. For large, liquid stocks, finding shares to short will be no problem. When entering the trade, just make sure to choose “sell short” as the opening transaction.

Sometimes, if you’re trying to short a thinly traded stock or a stock that is a popular short, there may not be any shares available to borrow. You may have to wait while the brokerage firm conducts a search for shares to borrow. (You borrow stock from long investors. When anyone opens a margin account they sign a “hypothecation agreement” that allows the broker to pledge their securities as collateral for short sales by other customers).

In the unusual event, there are no shares around to borrow, you’ll have to look for another security to short.

Stock short sale process:

1. Open a brokerage account.
2. Complete paperwork for a margin account.
3. Research short sale ideas
4. Create a trade plan
5. Locate borrowable shares to short
6. Enter the short sale
7. Manage the trade