Stocks: Shorting

There's more than one way to skin a cat. And, there's more than one way to make money on a stock.

Selling short is a way investors make money on stocks that they believe are going to decline in price in the near future. The important thing to remember: Shorting, while offering a smart way to make bearish bets, carries significant downside risks.

To sell a stock short, you borrow the shares from your broker, then sell the shares and hold the money and wait for the stock to fall. If it does, you buy the shares at the lower price and give them back to your broker, who gets a commission and interest for his or her troubles. For example, you borrow 100 shares of XYZ Co. at $100 a share from your broker, then sell them for $10,000. Let's say the stock drops 20% to $80 a share; you buy the shares back for $8,000, then return them to your broker and pocket your $2,000 profit (minus your broker's commission and interest, of course). ...