Short-Selling: What You Need to Know Now

From Three Strategies Every Short Seller Must Know:

1. The Valuation Short

To review, fundamental research on a company will typically result in earnings estimates which then translate into a price target. When this is accomplished we can then compare our price target to the current stock price. If the stock is below its price target then we will usually be inclined to buy the stock. However, if the stock is above its price target we might avoid or sell the stock, if we owned it. In some instances, the price target is significantly lower than our price target and the short sale of that security might be in order. For example, say that you value a stock at $40 and it is currently selling at $50. According to your analysis, selling short the stock at $50 will yield a $10 profit if the stock hits your lower price target.

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From Three Risks Every Short Seller Must Know

2. Capital Risk

Because of the unlimited loss potential associated with short-selling, the Federal Reserve requires these two important conditions:

Short-selling must take place in a margin account .

The short sale must be collateralized by the short sale proceeds plus 50% of the market value of the short sale. The short sale proceeds are posted as collateral for the "stock borrow." However, the 50% market value must be collateralized by cash or marginable securities.

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From Aggressive Stock-Picking: How to Squeeze the Shorts:

A heavily shorted stock has the potential to soar on any positive catalyst, because so many investors are placing bets against it. This creates an opportunity for aggressive buying -- in other words, betting against the "shorts" that the stock will experience a short squeeze.

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