Short selling stocks has been the object of much confusion. I remember when I first started investing and read about short selling stocks. I didn’t have a clue how all of it worked. It took a little while but I finally figured it out and it has become a common weapon in my strategic arsenal.
We can explain it over and over but instead, let’s look at a practical example from just the past few weeks. This practical example is one that took a gamble on and ended up making a nice amount of money in just one day.
Who would have known that Cash for Clunkers, the government program that allowed people to trade in their gas guzzling cars for a new car, would be such a success. Hundreds of thousands of cars were turned in and brand new fuel efficient cars were purchased.
[ReviewAZON asin=”0471710490″ display=”inlinepost”]In fact, I took advantage of this program. I gave the dealership my 1999 Ford Explorer and purchased a brand new 2009 Honda CR-V. I don’t normally purchase new cars but my old car was worth approximately $500. Instead, I got $4,500 for it. If I would have purchased a used car, I would have only made $500 on the trade in. In this case it made sense. What does my story have to with short selling stocks?
While I was at the dealership, and as I received quotes from the many dealerships in my area, I noticed something. They were very low on cars. Only a month ago, they didn’t know where to put all of their new cars and now they’re nearly out. Cash for Clunkers turned the ailing auto industry completely around. Since Cash for Clunkers, shares of Ford, the stock we’re going to look at, have gone up very healthily.
A little bit more about my story: I wasn’t planning to replace my ailing Explorer until it quit working. A couple more months would have saved me $700 but Cash for Clunkers moved my timeline up. I’m not the only one who did this so here is the realistic news. Cash for Clunkers resulted in huge sales for the auto companies right now which shot their stocks up but how many people will buy without the government giving them thousands of dollars to do it? Auto sales which may have happened later in the year were moved up but what’s next?
If you understand this, you understand the basis of my theory. I believe that Ford’s stock price was artificially inflated from Cash for Clunkers and I believe that most stock traders know this. On Friday, August 21st, the government announced that Cash for Clunkers was ending Monday, August 24th. Believing that people would realize that the end of the program is the end of the booming auto sales, I believed that people would sell their shares of Ford.
Short selling a stock means that I believe that the stock price would go down so I shorted a sizable amount of Ford stock thinking with the hope that stock traders would run with the money that Ford stock had made them.
The result? Today, August 24th Ford’s stock dropped 4.24%. In one day, the money I invested on Friday made 4.24%. I believed that the price would go down and it did. Remember that short selling stocks make money when a stock goes down rather than up.
If you understood that example, you are one step closer to short selling stocks.