article is an abstract of the book:
The Complete Guide
are some important points you must know before you short a stock.
Shorting means selling a stock when the seller doesn't own
the security. You may short a stock if you believe the stock price
will drop, and then buy back the stock later at a lower price. This
is called covering your position. This way you can make a
profit if a stock price is going down.
can't short stocks as easily as you can buy them. If you short a
stock, your broker must lend you the stock for the time you are
short and the broker himself must borrow the stock. Brokers
therefore provide a list of stocks which are available for shorts.
Stocks which are not on the list can't be shorted.
brokers haven't many stocks available for shorts, while others have
long lists of them. If you are interested in executing shorts in
many different stocks you should pick a broker who has a lot of
shorts available. The shorts list changes every day and the number
of shares a broker has available for shorts also varies.
You can't short a NASDAQ stock on a down-Bid because of the NASD
Short Sale Rule. This rule prohibits short sales in NASDAQ National
Market securities at or below the inside Bid whenever that Bid is
lower than the previous inside Bid. The rule does not apply, however,
to securities traded on the NASDAQ SmallCap Market or the OTCBB.
When trading NASDAQ National Market securities, you must wait for
an up-Bid, which means the Bid must be higher than the previous
one. You can short on a down-Bid only if you enter a short order
at least 1/16 above the inside Bid.
Your order execution software usually shows you if a stock is on
an up-Bid or a down-Bid, most likely with a red (down-Bid) or a
green (up-Bid) arrow somewhere in the Level II window. If the stock
is a NASDAQ SmallCap Market or a OTCBB security, you are allowed
to short on a down-Bid, in which case the tick arrow is black.
can't usually violate the short sale rule because your order will
most likely be rejected by your software. To get a "legal" short
on a down Bid you must enter the trade at least 1/16 above the inside
Bid if the spread is 1/16 or greater, or at a price equal to or
greater than the Ask if the spread is less then 1/16. A market maker
registered in a particular security has the advantage of being able
to do short sales on down Bids.
You can't short if your broker account is not a margin account.
A normal broker account is a cash account, which means you have
to pay in full for all purchases on your account. For example, if
you pay $50,000 into your broker account, you can buy stocks for
$50,000. With a margin account, however, you may be allowed to buy
stocks for $100,000 depending on the rules and conditions governing
you apply for a margin account, you must sign a margin account agreement
which includes all the rules and conditions on how the margin may
be used. The most important part of this agreement is the part that
allows a broker to liquidate all securities on your account in order
to meet the margin call against you - without your approval. Also,
the broker may be allowed to call in the loan at any time. There
are precise rules about this, and if you don't meet their requirements
you get the "margin call", which means you must pay in more cash
or liquidate securities to meet you requirements.
also have to pay interest, but this is usually rather low and for
a daytrader these costs are negligible. So why use margins at all?
Because of the leverage effect and the ability to do shorts. You
may also have some position plays that you don't want to sell. You
can use the margin for your short term trades, for example, and
keep all your current positions.
you buy a stock on full margin and the investment is successful,
you have twice the profit you would have gained doing it without
a margin (assuming you have used all the cash available plus the
margin for this trade). On the other hand, you can also double your
losses if the trade goes against you. Nevertheless, margins are
important to the daytrader, because he is often in several different
trades at once or he may want to buy higher priced stocks or just
do shorts. If you have a margin account you are not required to
use it, but it is useful to have it available whenever you need
more about shorting (margin example, short squeeze, short patterns
etc.) in the book The
Complete Guide to Daytrading