Short sellers buy high and sell low -- the flipflop of the old Wall Street adage. Let's say Biogamblers Tech is trading at $50 a share, but you think its headed for a fall. To sell BT short, you must borrow 100 shares from your broker. You now have a ``short position.''
A month later, BT reports a big drop in sales. Its stock tumbles to $40 and you decide to pay off your loan or ``cover'' your short position. You now buy 100 shares of BT at $40 and hand them over to your broker. Your profit: $10 per share minus transaction costs.
But suppose BT creates a bug that eats nuclear waste and its stock shoots to $90. Now you're in the hole. If you cover your position, you've lost $40 per share plus transaction costs. If you decide to wait, hoping it will fall, you still must ante up cash or stock for your broker.
When you borrowed the 100 shares at $50, you had to put up $2,500 in cash or securities -- 50 percent of the loan -- as collateral. The stock exchange requires that upfront money must stay above 30 percent of the market value of BT (or $5 whichever is more). Since your 100 shares of BT stock are now worth $90 each, you must put in another $200 to boost your collateral to $2,700.
Another short sale rule is that you can't take a short position while a stock is falling (over-the-counter stocks are excluded from this rule). You must wait until an ``uptick,'' or a rise of one-eighth of a point.
Short selling is risky. When you buy a stock, go ``long,'' the most you can lose is total price of the stock. But when you short, your losses are theoretically unlimited. Of course, short sellers often use stop-loss orders to limit their losses. -- D. C. S.