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As I understand in order to put in a short order, one must have at least 150% of the trade value in their trading account.

For example, if I were to short 200 shares of a stock which is currently trading at $20, if I put in a short order to buy these shares at $19. I would need: 200 * $20 * 1.5 = $6000 minimum to ask my broker to perform this trade.

How long do you have till the short order expires? For example if the stock goes up to $21 the next day but 2 days after that goes down to $19, is my order still successfully fulfilled?

And what exactly do I profit from the short? I understand it is the difference in the value of the stock. So if my initial investment was $4000 (200 * $20) and I bought it at $3800 (200 * $19) I profit from the difference, which is $200. Do I also receive back the extra $2000 I gave the bank to perform the trade?

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First, you are not exactly "giving" the brokerage $2000. That money is the margin requirement to protect them in the case the stock price rises. If you short 200 shares as in your example and they are holding $6000 from you then they are protected in the event of the stock price increasing to $30/share. Sometime before it gets there the brokerage will require you to deposit more money or they will cover your position by repurchasing the shares for your account.

The way you make money on the short sale is if the stock price declines. It is a buy low sell high idea but in reverse. If you believe that prices are going to drop then you could sell now when it is high and buy back later when it is lower. In your example, you are selling 200 shares at $20 and later, buying those at $19. Thus, your profit is $200, not counting any interest or fees you have paid. It's a bit confusing because you are selling something you'll buy in the future.

Selling short is usually considered quite risky as your gain is limited to the amount that you sold at initially (if I sell at $20/share the most I can make is if the stock declines to $0). Your potential to lose is unlimited in theory. There is no limit to how high the stock could go in theory so I could end up buying it back at an infinitely high price. Neither of these extremes are likely but they do show the limits of your potential gain and loss.

I used $20/share for simplicity assuming you are shorting with a market order vs a limit order. If you are shorting it would be better for you to sell at 20 instead of 19 anyway. If someone says I would like to give you $20 for that item you are selling you aren't likely to tell them "no, I'd really only like $19 for it"

  • I was 80% of the way through writing an answer and then you posted this. You covered my points better than I did, and importantly raised the issue of unlimited losses. – ChrisInEdmonton Aug 10 '16 at 15:44
  • Please read the numbers again. Stock is trading at 20, but he places an order to short at 19. His last paragraph is a bit contradictory. Your answer may be 100%, but the question can use editing. – JoeTaxpayer Aug 10 '16 at 15:53
  • @JoeTaxpayer I have edited my question. Also could someone address the question of how long one has for the trade to be closed successfully. Is there no limit? Is it similar to a regular long trade where you can select for it to be either a day trade or finished by a certain day? – sawreals2 Aug 10 '16 at 15:58
  • @JoeTaxpayer I edited my answer for clarity however if the current price is $20 the chances of wanting to sell for $19 are unlikely unless we are talking about some technical analysis. Based on the question I'm going to guess that isn't the case. – homer150mw Aug 10 '16 at 16:01
  • Sorry, I misread what the question said. I read that the stock was selling for 20 but the sell order was placed for 19, not the buy order – homer150mw Aug 10 '16 at 16:03
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The margin money you put up to fund a short position ($6000 in the example given) is simply a "good faith" deposit that is required by the broker in order to show that you are acting in good faith and fully intend to meet any potential losses that may occur. This margin is normally called initial margin. It is not an accounting item, meaning it is not debited from you cash account. Rather, the broker simply segregates these funds so that you may not use them to fund other trading. When you settle your position these funds are released from segregation.

In addition, there is a second type of margin, called variation margin, which must be maintained while holding a short position. The variation margin is simply the running profit or loss being incurred on the short position. In you example, if you sold 200 shares at $20 and the price went to $21, then your variation margin would be a debit of $200, while if the price went to $19, the variation margin would be a credit of $200.

The variation margin will be netted with the initial margin to give the total margin requirement ($6000 in this example). Margin requirements are computed at the close of business on each trading day. If you are showing a loss of $200 on the variation margin, then you will be required to put up an additional $200 of margin money in order to maintain the $6000 margin requirement - ($6000 - $200 = $5800, so you must add $200 to maintain $6000). If you are showing a profit of $200, then $200 will be released from segregation - ($6000 + $200 = $6200, so $200 will be release from segregation leaving $6000 as required).

When you settle your short position by buying back the shares, the margin monies will be release from segregation and the ledger postings to you cash account will be made according to whether you have made a profit or a loss. So if you made a loss of $200 on the trade, then your account will be debited for $200 plus any applicable commissions. If you made a profit of $200 on the trade then your account will be credited with $200 and debited with any applicable commissions.

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And what exactly do I profit from the short? I understand it is the difference in the value of the stock. So if my initial investment was $4000 (200 * $20) and I bought it at $3800 (200 * $19) I profit from the difference, which is $200. Do I also receive back the extra $2000 I gave the bank to perform the trade?

Either this is extremely poorly worded or you misunderstand the mechanics of a short position. When you open a short position, your are expecting that the stock will decline from here. In a short position you are borrowing shares you don't own and selling them. If the price goes down you get to buy the same shares back for less money and return them to the person you borrowed from. Your profit is the delta between the original sell price and the new lower buy price (less commissions and fees/interest). Opening and closing a short position is two trades, a sell then a buy. Just like a long trade there is no maximum holding period.

If you place your order to sell (short) 200 shares at $19, your initial investment is $3,800.

  • If the stock increases to $20 your position is now at a loss of $200 ($3,800 - $4,000).
  • If the stock decreases to $18 your position is now at a profit of $200 ($3,800 - $3,600).

In order to open your $3,800 short position your broker may require your account to have at least $5,700 (according to the 1.5 ratio in your question). It's not advisable to open a short position this close to the ratio requirement. Most brokers require a buffer in your account in case the stock goes up, because in a short trade if the stock goes up you're losing money. If the stock goes up such that you've exhausted your buffer you'll receive what's known as a "margin call" where your broker either requires you to wire in more money or sell part or all of your position at a loss to avoid further losses. And remember, you may be charged interest on the value of the shares you're borrowing.

When you hold a position long your maximum loss is the money you put in; a position can only fall to zero (though you may owe interest or other fees if you're trading on margin). When you hold a position short your maximum loss is unlimited; there's no limit to how high the value of something can go. There are less risky ways to make short trades by using put options, but you should ensure that you have a firm grasp on what's happening before you use real money.

The timing of the trades and execution of the trades is no different than when you take a plain vanilla long position. You place your order, either market or limit or whatever, and it executes when your trade criteria occurs.

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