Three Strategies Every Short Seller Must Know

In the last installment of The Finance Professor, I explained the mechanics and operational aspects of short selling. Now I want to address short selling from a trading and investment perspective.

There are several factors that will motivate a trader or investor to short sell a security . Here are the three main strategies and the reasoning behind them.

1. The Valuation Short

I discussed the concept of fundamental stock trading in an earlier lesson. 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. ...