Short selling involves selling shares of a company that an investor does not own, creating a short balance in their account. The investor hopes to recover the money by later buying shares to pay off the balance. Short selling is riskier than buying a stock, and brokerage firms often place limits on margin accounts.
A short balance refers to the account of an investor who has short-term sold the shares of a company. Short selling is quite popular for many investors. An individual can open a trading account on margin, which means that the investor can borrow money from the brokerage firm that buys and sells shares for the investor. Short selling occurs when the investor sells shares of a stock that he does not own, effectively creating a short balance in his account. The investor hopes to recover the money by later buying shares to pay off this balance.
Short selling stocks allows investors to make money by betting that a company’s stock price will fall in the future. As the stock price falls, the investor makes money. The increase in the stock price will reduce the investor’s earnings on the investment. Not all investors can trade on margin; it depends on your brokerage account and the funds available to pay the brokerage house for the short balance. Cutting stocks is riskier than buying a stock because the potential to lose money is greater. For example, it is unreasonable to think that the price of a company’s shares will fall to zero, which means that the investor can sell the shares and limit losses.
Investors who sell shares short can lose their entire investment if the company’s share price is higher than the original purchase price. This will create a significant short balance in the investor’s account, meaning money is needed to pay off the brokerage. While stop losses can help mitigate these losses, failing to act quickly can create a difficult investment situation.
Brokerage firms use basic bookkeeping to track the short balance in an investor’s account. The total balance must equal the total number of shares outstanding multiplied by the original purchase price. Gains and losses are not necessarily recorded until the short balance is rectified, that is, the investor buys shares to cover the short position. However, if the brokerage firm decides to keep an up-to-date account, it will post entries known as “mark-to-market.” These entries represent the change in the share price and will help the brokerage firm monitor the total balance owed by investors. Upon closing the account, any remaining debit or credit balance will represent money owed by or to the investor, respectively.
Brokerage firms often place limits on margin accounts, or the number of shares an investor can short. Short selling stocks can allow investors to act unethically. Not only do they borrow money from the brokerage company in terms of a short balance, but they can manipulate the market by spreading negative rumors about the company they shorted stock with. This creates a profit through the resulting decline in the stock price.
Smart Asset.
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