In our last lesson we continued our module on how to place stock trades with a look at how to locate and read a stock quote. In today's lesson we will continue our course on the logistics of stock trading, with a look at position sizing, and how to buy and sell stocks short.

As we learned about in our first module, a stock is basically part ownership in a company, which is why people often refer to stocks as shares. The smallest trade that can be made in a particular stock is for 1 share, which is what the price represents in the quote window that we covered in our last lesson. Similarly, as you will notice if you look in your quote window, the smallest move a stock can make is 1 penny per share, as represented by the second decimal place in the stock quote.

Generally traders will trade in 100 share increments when trading stocks which is referred to as a "round lot". It is possible to trade less than 100 shares (referred to as an odd lot) or more than 100 shares that are not in increments of 100, which is referred to as a mixed lot. Depending on where you are trading there may be additional fees for trading sizes other than 100 share increments so be sure to check with your broker.
So lets say for example that Microsoft is currently trading at $25.00 a share and you feel from your analysis that the price is going to rise to $30.00 a share. In this case you would buy to enter the trade, as you want to profit form the price increase of the stock. Lets say for our example that you buy 100 shares, which will thus cost you 100 shares X $25.00 a share which equals $2500 (plus commissions which we will cover in a later lesson). If the price of the stock goes up by $5 per share to $30 then you have earned 100 shares X the $5 per share gain which equals $500. Pretty simple.
While many people are familiar with the above example of buying stock, what many people are not as familiar with is the concept of selling stock short. Lets say for example that your analysis is telling you that instead of the price of Microsoft stock rising $5 per share, from $25 a share to $30, it is going to fall $5 a share from $25 to $20 per share. Just as you can profit from the price of a stock going up in value by buying, you can profit from the stock going down in value by selling the stock. You do this by borrowing the number of shares that you wish to sell short through your brokerage, selling them in the open market, and then buying them back when you are ready to exit the trade.

Lets look at how this would work with our example of Microsoft outlined above. Since I think the value of the stock is going to fall from $25 to $20, I sell 100 shares of Microsoft at $25 crediting my account 100 shares X $25 per share or $2500. If I am correct, and the value of the stock falls from $25 to $20, then I can buy the stock I have borrowed and sold in the market back for 100 shares X the $20 share price of the stock, which amounts to $2000. As I originally sold the 100 shares of stock at $2500, and now I am able to buy the same 100 shares of stock back for $2000 to replace the shares I have borrowed, I have just made $500 on my trade.

On the flip side of this, if I sell the stock short at $25 and the price instead rises to $30 per share where I exit the trade, I have now had to buy back the stock I purchased for $2500, at a price of $3000. In this case I would have lost $500 on the trade because the price moved up, which in the case of a short sell is a move against the trader.

That's our lesson for today. In our next lesson we will look at the different types of orders which can be used to enter and exit the market, starting with the most basic order type, the market order so I hope to see you in that lesson. As always if there are any questions or comments please leave them in the comments section below, and good luck with your trading!

Links on Short Selling:

Short (finance - Wikipedia, the free encyclopedia)

Short Selling: What Is Short Selling?

Short Selling - InvestorGuide University

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.