Shorting

I’m going to assume you know nothing about the stock market. I’m learning, so I think I’m right

For a while, I didn’t give a flying hootenanny (hilarious word that I just remembered exists) about the stock market. Then I learned that my boyfriend has paid for two cars, pays for his apartment, and pays his college tuition with money earned in the stock market.

Losing money is scary, so one day during junior year, I told my friend Taryn (freaking awesome human being – I NEED to hangout with her more next semester… she lives in Washington so this is basically the last of the time we have for our friendship… so sad) that I was going to set up a nice Excel doc and start paper trading. She showed me Investopedia’s stock simulator game.

It’ fantastic. You’re given $500k and you trade stocks in a fashion very similar to the real thing. The site’s directly connected to the real time stock market (with a 20 minute lag). You have to wait 20 minutes or so for the trade to go through, so you’re not 100% sure you’re going to get the stock at the same price as it was when you bought it. You can buy/sell at market, or set a stop or a limit. I still don’t totally understand the difference between stocks and limits, but limits are better. Stop: once the stock hits a certain price, it becomes a market order, so it could way up or way down in the 20 minutes it takes to fulfill your order. Limit: It won’t sell (buy) your stock until it’s higher (lower) than the specified price. You can also short stock. I’ll get to that later.

I don’t understand why anyone buys stock without setting a stop or limit.

Well, I do. But it’s so unnecessarily risky. Here’s an example of why people do NOT want to use limits: Both Jim and Harry buy a stock at $10. Jim sets a sell limit for $12. Harry hopes it will rise higher.

  • Scenario 1:  The stock rises to $12 at 1 p.m. Jim’s brokerage firm sells the stock for him. Jim’s made $2. The stock continues to rise as the day goes on. The day ends with the stock at $15. Harry is happy because he’s made $5. Jim is mad because he knows he could have made $3 more if he didn’t set a limit.
  • Scenario 2: The stock rises to $12 at 1 p.m. and Jim’s stock is sold, but because the stock market is highly volatile, it drops to $9 by the end of the day. Harry has lost $1 and Jim has made $2.
  • Scenario 3: For this scenario, assume Jim has set a sell limit at $9. Jim decides he will manually sell the stock if it goes up, but wants to to use the limit to restrict his losses. The stock starts dropping right away. At the end of the day, the stock price is at $5. Jim has lost $1, but his limit has prevented him from losing any more. Harry has lost $5.

So yeah, I get that people don’t set limits. They can’t handle Scenario 1, thinking “I could have made more!” Anthony says that’s half the battle while investing. I have no desire to get crazy with that stuff. I’m a very conservative estimator. I call myself a realist, but one could argue I tend to be a pessimist. I assume everyone and everything is going to be a disappointment, and I celebrate when things even go a little well.

Mom says the market runs on fear and greed. My fear of losing money is super crazy intense, but my greed in wanting tons of money is considerably less intense. I will be happy to make an extra $50 a week if I can pull it off.

That’s when we get into shorts.

Short selling a stock is betting against it. You make money when the stock price falls. Like I said, I’m still learning, and there’s a LOT to learn about short selling. It’s very confusing. So far, I think I understand short selling WITHOUT setting a limit. You buy/sell/engage in/order a short. Let’s go with order. It’s confusing because the logistics of a short include an individual who puts his shares out there to be borrowed, your broker borrows those shares, those shares are sold at your specified lower price, your broker buys back shares to replace the borrowed shares he sold, and you profit from the difference between the high price of the past and the lower price today. I’m pretty sure that’s how it works – kinda. Anthony tried to explain it to me.

Point is, you order the short. You make money if the stock price goes down, and you lose money if the stock price goes up. What I don’t understand is the cash part. When you buy a stock normally, you give up $10 cash for the stock, then earn $12 by selling the stock (if you sell it at $12). It seems that you order the short paying nothing but the commission fee. You only put your own cash in when the stock goes up. You owe money.

What about short sells with limits? This is where it gets REALLY fuzzy, and I still haven’t figured it out. It seems like you can set the limit during the initial order. In normal investing, you cannot set a limit to sell a stock in the same order that buys the stock, as I understand it. So this makes me think that when you set a “limit short” the whole event goes down as soon as the stock hits the price you specified. This would mean that 100% of the time, you either make money, or lose nothing at all. That CANNOT be real. Dad is sure that’s not real. Anthony thinks it might be real. I’m going to do more research.

Anthony found me a PDF published by Merrill Edge (the investment account provider he uses) so I can learn more about it. I went onto Merrill Edge’s website and briefly chatted with one of their representatives. Carrie G. told me that all Edge trading fees are priced at $6.95, including shorts. To open a margin account (the only account that allows shorts), you must deposit $2,000 (which makes sense). She was great. I left an excellent review. I love when customer service chats are offered on websites. They’ve only helped me.

The important thing is that I AM SO EXCITED TO BE EXCITED ABOUT THE STOCK MARKET. I wanted to learn, but Anthony’s a master at tech / big pharma (pharmaceuticals) so this was what I was hoping for because 1) it would be unproductive to figure normal investing out myself because all the information is at my disposal through him, and 2) I want to figure out something new – something he doesn’t know. I didn’t want to pick a new industry to focus on because the constant research he does on IPO’s and likely price spikes is too stressful for me. Short selling is definitely the way to go for me. I’m a pessimist when it comes to society and the stock market. I don’t need to know how to make a million dollars. I just wanna make $50 a week. I am so excited about short selling in my game. I wanna get so good at it. I am so excited. This is MY GAME.

Well, unless I learn I’m totally wrong, then I guess I’m screwed.

Update: I’m doing more research and I’m starting to think that Investopedia has an error in their game system. I don’t think you’re able to order a short and “cover” (which is ending the short and accepting your gain/loss) at the same time. This makes sense. Also, Merrill Edge has to borrow the shorted stocks for you, so if there are no shares available to be borrowed, you can’t borrow them. Totally understandable. I don’t mind this. BUT if Merrill Edge can’t hold on to these borrowed shares for whatever reason, you are FORCED to cover your short at WHATEVER PRICE IT’S AT. Now THAT’S terrifying.

In which case, I have a backup plan. I use stops/limits to my advantage as previously specified. I buy stock, setting a limit a cent below my initial investment OR I set up a short a cent above my the initial stock price. I’m a big fan of this. This is a good way to make $20 a week or more. I’m about it.

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