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What Are Short Stocks?

The "short" in the term short stocks refers to the short-term nature of the arrangement.

More Info: Typically, these stocks are lent by a brokerage house to an individual broker, who then turns around and sells them to another individual or broker, with the caveat that they must at some point buy them back and return them to the original brokerage.

The game of trading in short stocks centers around the notion that if the stock value plummets after the first individual has sold them to the second, that person can then buy them back at the lower price and return them to the brokerage for the full original per-stock purchase price, pocketing the difference. However, the opposite is also true. If the individual who borrows the stock from a brokerage house then sees the value of the stock rise from the original price, they will have to eventually, within a time limit or to mitigate against further losses, buy back the stock at a higher price than what they are going to get back from the brokerage. In that case, the short stock trader will lose money.

The Art of Picking Short Stocks

The art of picking a good "short stock" sell candidate is tricky, with no shortage of systems out there promising guaranteed results. Among the factors worth looking at for those willing to enter this higher risk arena are: technical trends that affect the company in question; lowered estimates; imminent corporate tax losses; and declining sector or industry vertical trends. In terms of the calendar year, the fourth quarter of a declining company's cycle is often a clever time to jump in with a short stock purchase. Often, both individual and institutional investors will choose to unload some of that stock before year's end, to basically reap the tax benefits. This will turn will generally help drive the stock price lower.