Plenty of risky investment strategies exist that could make you a lot of money. From the cherry tree of options out there, shorting stocks is definitely one of the riskiest ones. That doesn’t mean you can’t do it successfully. To explain how to short stocks, we’ve selected Robinhood as a potential broker for the job. Robinhood is a well-known broker that comes with a zero-commission on stock trading. Unfortunately, it does not offer short selling.
While Robinhood excels in other areas, you should get to know the service first before trying this strategy. Luckily for you, we have a guide on Robinhood where we compare it to Public – another popular broker app. Here is our guide on the subject. We highly recommend you go through it first if you’re planning on trading on Robinhood.
But when it comes to shorting stocks, it’s an entirely different gravy. Buying stocks is one thing, but betting against them is very risky. Here is what you need to know about shorting and how to short stocks on Robinhood.
What Does It Mean To Short Stocks?
To get a proper grasp on the subject, we obviously have to start by explaining what shorting stocks means. Shorting stocks means betting against a stock. What this means is that you’re essentially betting on the fact that the stock’s price will go down. Shorting a stock is most common with overpriced stocks. Investors go through tons of data to determine which stock has an unrealistic price. By shorting the stock, investors are hoping that the price will decline.
There are obvious risks with shorting stocks. The biggest risk is if the price doesn’t decline or drop. If the price goes up, you are obliged to cover the losses. While that’s the gist of shorting stocks, allow us to explain how it actually works.
How Does Shorting Stocks Work?
The next explanation before we get into how to short stocks on Robinhood is all about how it works. Since shorting stocks means betting against a stock, you need to borrow the shares first. But with shorting, you hold a position. You’re essentially borrowing the stock, and hoping that it drops. In that case, you buy back the shares at the lowered price and pocket the difference from the original position.
Let’s give you a simple example.
Let’s assume you’ve borrowed 100 shares of stock XYZ. The price of the XYZ stock is $100 per share. So you’ve essentially borrowed $10,000 worth of XYZ shares. When shorting, you’re hoping to buy back the shares at a lower price. Let’s say that after a few weeks, the price of XYZ is $50. You can then buy back the stock at $50 and sell it back to the broker. So how do you make your money since the stock obviously dropped in price? Well, you make $10,000 from the initial sale. You then deduct the cost it took you to buy back the shares at $50. In our case, $5,000. You also deduct the fees the broker charges and you’ve roughly gained $5,000.
As mentioned previously, the risk here is if the stock doesn’t drop in price. If the price goes up, you have to pay up the difference. Since you are obliged to return the borrowed shares, you are also obliged to cover for the loss. This is what makes shorting stocks so risky.
But with all that out of the way, let’s look at how to short stocks on Robinhood.
Can You Short Stocks On Robinhood?
You can’t short stocks on Robinhood. So that begs the question, how do you short on Robinhood, if the platform doesn’t allow it? While shorting isn’t possible, what you can do is use inverse ETFs or put options. Both inverse ETFs and put options are different from shorting. Allow us to explain it.
• What Is A Put Option?
Since Robinhood short selling isn’t possible, one way to achieve the same is to use put options. Put options are similar to short selling but still different. A put option gives you the right to short sell a security at a predetermined price. A huge difference is that a “put” doesn’t oblige you to do so.
Put options are one way of shorting stocks on Robinhood.
• What Is An Inverse ETF?
Investing in inverse ETFs is also similar to shorting stocks. However, the difference here is that you’re betting on the decline of an exchange-traded fund (ETF). Much like put options, inverse ETFs are designed as long-term investment options. Shorting stocks, on the other hand, is a more short-term investment option.
How To Short Stocks
The main highlight of shorting is that you need a margin account. That isn’t the case with inverse ETFs and put/call options. So naturally, the first step will be to open a margin account. Robinhood short selling isn’t possible, but you can still open a margin account.
Step Number One: Open A Margin Account
To open a margin account on Robinhood, you need to meet a couple of requirements. The first requirement is to have $2,000 on your account. The amount could be in USD or it could be part of your portfolio. The second requirement is meeting the margin maintenance. On Robinhood, this means you need to have 25-35% of the value of the position in your account. If you’ve borrowed $1,000 worth of XYZ stocks, that means you need to have 25-35% of that value in your Robinhood account at all times. In simple terms, you need to have $250-$350 in your account.
Step Number Two: Identify A Short-Sale Stock
The purpose of this guide is to explain short selling. So we will go with the hypothetical scenario where Robinhood does offer short selling. Granted, you can use this guide with a broker that does allow short selling.
We mentioned earlier that likely short-sale candidates are stocks that are overperforming. This is usually the case with stocks that see a surge in price with no financial explanations to justify their price. When identifying short-sale stocks, investors should look at the following signs. The number one sign is to look at stocks that are on the rise despite the market being down or steadily declining. Another sign is if the stock is outperforming its 52-week high. A third sign is if the price of the stock is increasing at a very quick pace.
These are all signs that will help you identify a short-sale stock.
Step Number Three: Open A Short Position
The next step is to open a short position. This is quite simple. A short position is an exact time you sell the borrowed shares.
Step Number Four: Cover
This is the final step in how to short stocks on Robinhood (hypothetically). To cover means to buy back the shares after the price declines. After you cover, you immediately finish the short sale and get your returns (if the stock has indeed declined).
With all that said, can you short on Robinhood? No. But we’ve given you a full explanation of what shorting stocks is, how it’s done, and how to do it in the case the Robinhood short selling option does become available.
Partner at Vega Capital Management - a private funds management company.
An experienced portfolio manager with 10+ years of proven and reputable track record in investment management and financial analysis. Currently, a partner at one of the fastest-growing private fund management companies in southeast Europe, Kiril has been tending to a loyal international base of client-investors and partners. When he is not crunching numbers and increasing his client’s wealth, he reminisces about his Michelin-star restaurant cheffing years and fondness of the culinary arts.