Yesterday the investment banking firm Bear Sterns stock fell 47% and I learned an advanced investing technique called shorting. Most people buy a stock in the hopes that the value will increase in the long run, on the flip side when an investor goes short they are anticipating the value to decline.

The basic idea of shorting is to borrow shares of a stock from a broker , selling it immediately then buying the same number of shares back. If the price at which the shares were bought back is lower then the price at which they were borrowed, the investor profits from the difference.

Here is an example:

You borrow 10 shares of company ABC at $50. You immediately sell the shares at 10 x $50 = $500. The price of the stock falls to $40 a week later and you decide to cover, so you buy back, 10 x $40 = 400. You just made $100 in profit by shorting.

It sounds easy enough but it is risky, very risky. There could be the case where you tried to short a stock only to see that the price kept on rising. At some point you will have to cover the number of shares you originally borrowed.

Here is an example:

You borrow 10 shares of company ABC at $50. You immediately sell the shares at 10 x $50 = $500. The price of the stock rises to $70 a week later and you decide to cover, so you buy back, 10 x $70 = 700. You just lost $300 by shorting.

So be careful when shorting because you are playing with money you dont have. In the next article I will discuss other aspects of this technique.

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