How to Short Sell a Stock on TD Ameritrade
Short sellers often have a bad reputation in the market, but shorting stocks is necessary for any healthy market. Short sellers are often the first to detect questionable accounting practices or misleading statements by management. But short selling is also extremely risky and requires a great deal of diligence, timing and luck. Here’s how to short sell a stock on TD Ameritrade.
How to Short Sell a Stock on TD Ameritrade
The first thing you will need to short sell a stock is a margin account with sufficient capital at your disposal. Margin accounts allow traders to apply leverage by borrowing money or stock from the brokerage. To qualify for a margin account, you will need to keep a minimum of $2,000 in your account at all times.
You will also need to maintain specific margin requirements for your account equity. At TD Ameritrade, this rate is 30%, which means that you must have at least enough funds to cover 30% of your total position. If your account falls below this 30% threshold, be prepared to face a margin call. If you cannot meet the margin call, TD Ameritrade may close out your position at a loss without notifying you. Here are the steps to start on a short position.
- Identify a short action: Your first step is to develop a thesis on a short stock. What headwinds are different companies and industries facing that could cause their stocks to drop? You will need to consider the economic environment and the individual performance of the companies you are considering. For example, technology companies have been popular targets for short sellers as interest rates have made the cost of borrowing capital higher. Develop a trading plan and execute it, just as you would if you were buying a stock for a traditional investment.
- Make sure TD Ameritrade has stock to borrow: Not all stocks have enough cash to be easily borrowed. Remember that a short sale means that you borrow shares from the broker and immediately sell them in the open market. This is often easier said than done, as TD Ameritrade needs to find borrowable stocks and lend them to you. The less liquid the stock, the more difficult it will be for the broker to locate stocks, and hard-to-locate stocks may be more expensive to borrow. TD Ameritrade will not permit naked short selling, which is the short selling of stocks without actually locating stocks to lend.
- Borrow shares from the broker according to your instructions: Use your trading plan to determine how, when and how many shares to borrow from the broker to sell short. The actual short sale of the stock will be commission-free, but you will still have to pay margin interest if you use borrowed funds. For example, if you borrow $5,000 to open a short position of $10,000, you will be charged interest on that borrowed $5,000. Usually, TD Ameritrade charges 7% to 9% interest on borrowed funds, and these costs should be factored into your overall gains and losses.
- Selling shares on the stock exchange: When the broker locates the shares, they will be borrowed (usually from another investor) and placed in your account. Once the shares are in your account, you are free to sell them on the open market. The sale of borrowed shares carries no commission, like any normal purchase and sale of shares on the TD Ameritrade platforms. However, you cannot cash in profits yet.
- Redeem shares and return them to the broker: Once you’ve shorted the borrowed stocks, you’re playing the waiting game. Your broker will require the shares to be returned at some point, so the hope with a short sale is that the price has fallen enough that you can buy back the shares later and pocket the difference between the short sale price and the redemption price. Redeeming shares after they have refused to return to the broker is called short hedging. Ideally, the stock will remain liquid during its decline so that enough shares can be easily redeemed and returned. Once the broker recovers the shares, the short position is closed and you are free to take the profits.
$600 cash and free exchanges for 60 days
How to choose stocks to sell
Picking stocks short is the hardest part of short selling. Even poorly managed companies can see their stocks rise in value over long periods of time and completely wipe out the profits from any short selling. Like buying options, short selling is not only about finding the right companies, but also finding the right time for the trade.
Fundamental and technical analysis can often go hand in hand when looking for short stocks. Does the business have a lot of debt and minimal revenue? Are there any accounting or production issues? And is the stock chart showing a dynamic downtrend? Compare the two schools of thought to narrow the scope of actions short.
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The benefits of a short position
Shorting a stock can be a profitable business, but there are also other reasons why investors short stocks. Here are some benefits of holding a short position.
Take advantage of unprofitable businesses: Many of the stocks that flew high during the COVID-19 pandemic were on unsustainable runs. Interactive Peloton Inc. (NASDAQ: PTON) and Focus on video communications (NASDAQ: ZM) are good examples. An investor who shorted these unprofitable companies as the pandemic began to wane saw huge gains if he timed his trade correctly.
Protect against market declines: Short selling is not just a matter of speculation. Many investors short sell certain stocks or ETFs to insure their capital against bear markets. If you think the market may go down, but don’t want to offload certain positions and create taxable events, short selling a stock or index will protect your capital without the need for an exit ramp.
Control a larger position: With margin, you can control a larger position than your actual capital would allow and enter a short position. If your trade is successful, you will increase your profits without the need for an additional cash injection.
The risks of taking a short position
Short selling is often risky and expensive, which is why most investors avoid it altogether. Even the most carefully crafted short selling plan can go awry if the market moves against you, and you may find it difficult to unload your position. Here are some disadvantages of short selling to be aware of:
High borrowing costs: Margin is not free and you will pay interest on any capital borrowed from the broker. At TD Ameritrade, these rates can be as high as 9%, so always factor borrowing costs into your trading ideas.
Losing money in bull markets: The past decade has seen one of the biggest bull markets in modern history, creating a challenging environment for short sellers. Even the most suspicious companies can find the money to borrow for their operations at low rates. When bull markets are roaring, short selling is extremely difficult to master.
Shares can be hard to find: To make a short sale, you may need to repurchase the shares you sold short and deliver them to the broker. But what if you can’t find enough stock? If the stock is limited, other short sellers may buy it back sooner, which creates demand for the stock and pushes the price up.
Short compressions can be disastrous: The world has become familiar with short presses during the GameStop Corp. (NASDAQ: GME) in early 2021. When a stock makes a big gain in a short period of time, short sellers may face margin calls as their positions shrink. This causes a rush to find and buy stocks at a reasonable price to get back to the broker. When both buyers AND short sellers attempt to accumulate stocks, a feedback loop known as the short squeeze results. A short squeeze is a short seller’s worst nightmare because a carefully crafted trading plan can become useless within days or hours.
Frequently Asked Questions
questions and answers
Can you short on thinkorswim?
Yes, TD Ameritrade clients can short sell stocks using the thinkorswim platform. In fact, thinkorswim makes it easy to short circuit.
To short sell a stock, you will need to find and borrow stocks from a broker and immediately sell the stocks in the open market. Then, after a price drop, you buy back the shares and return them to the broker pocketing the price difference.