I think the end of the previous writing entry has steered me into my next entry which will lead into some shorting basics and options introduction.
The key to a great fortune does lie at the simple fact that the market and all its goods and services go up and down in price. Some can have success using the price arbitrage between buyers and sellers, others can precognize price action and try to stay ahead of it. One of the most overlooked yet powerful tools one can use that exists can be used when the price of an asset goes down in dollar terms. “Huh? You can make money when the price goes down?!” is not an uncommon response when I tell people this!
Two ways you can make money on the downside are a SHORT SALE and a PUT OPTION.
The SHORT SALE is a pretty easy concept once you get the hang of it. Say you have a technology company whose trading symbol is XYZ and it is trading at around $10 a share. You think it had topped out and going to decline in price. You can go to your broker and say I want to short XYZ. If your broker has or can find shares available to buy, you can borrow the shares from your broker and sell those shares into the market, that is the short sale. On the balance here we will:
Sell 100 shares at $10 per share into the market, so we would receive $1000 for selling those shares into the market. Now we have $1000 we will hold on to.
XYZ falls 25% and is now at $7.50 per share. You could buy back 100 shares for $750 and thus pocket $250, but you think it will fall a bit more..
XYZ falls then to around $5 a share, a big 50% loss, which will be your 50% gain!
Now you decide well I will buy 100 shares back at $5 a share which is $500, so out of that $1000 we are holding, we bought those 100 shares for $500, and still have $500. We will pay back the broker the 100 shares, and pocket the $500!
Well what if I cannot borrow the shares or money for whatever reason? That is a good question, and is where the other tool makes a good fit. We are going into options for this one, so I will have to explain them so we can understand our other path clearly. Thus this will be the subject of the next post!
