Do you know how to borrow a stock? You’re probably familiar with buying and selling stocks. You even might be dabbling already with your modest $1,000 trading account.
Table of Contents
- How to Borrow a Stock
- How Much Does It Cost to Borrow a Stock?
- What Is a Hard to Borrow Stock?
How to Borrow a Stock
- Here’s how to borrow a stock:
- Choose a good short-selling broker like SpeedTrader or Interactive Brokers
- Make sure they have good short locates
- Sell the ask/bid or place a limit order to create a negative short position
- Buy the ask/bid or place a limit order and cover your position
What if I told you there’s another way instead of buying and selling? What if I told you that you could borrow a stock? Yes, I mean borrow. Like borrowing and giving back.
Pro investors have learned how to borrow a stock, make money and then return with a small fee. Today, I will show you how you can do what the pros do. But remember, the trading arena is open to everyone, not just the pros.
To make this easy to understand, borrowing is like renting. So instead of buying the $250,000 high-performance car, you can get your fix by renting it for the afternoon. What’s great about it is that you’re not paying for the $1,000 oil changes and $2,000 tires. Which, for reference, needs to be changed more often than diapers on a newborn.
All of this sounds risky to me, which is why borrowing might be the safer bet. Our trading service goes both long and short with stocks and options. It gives you different ways to trade the market.
You Want Prices to Fall
People invest in stocks with the hope of making money. They aim to ride the profit train on the tails of a company’s positive news and soaring profits.
But did you know there’s a whole other class of traders, called short sellers, who do the opposite? The complete opposite.
Short sellers are looking for companies that are tanking due to negative news; think news stories about people dying due to using the company’s product.
I know, I know, that may be an extreme example, but you get my point. Their goal is to cash in on the falling stock prices that are surely about to happen.
Stock trading is great when you have strategies to make money in any market. First, however, you must ensure you’re safe with it.
Reviewing What Does Borrowing a Stock Mean?
You’ve done your research and want to take a short position. But, unfortunately, people dying typically will hurt the share price. So, you go to your broker and borrow the shares.
You have no idea where the shares come from or to whom they belong, but that doesn’t matter. They may come from another trader’s margin account, out of the shares held in the broker’s inventory, or even from another brokerage firm.
Remember that the broker is the lending party once you place the order. The individual investor is not doing the lending.
In other words, the broker assumes any benefits along with any risk. Take our online trading courses to learn how to borrow a stock.
Money. It always boils down to money. And that’s what your broker will get. Firstly in the form of interest from lending the shares and secondly in the commission paid by you to use their service.
And why would you have to pay a commission? Because they are taking on the (your) risk. Think about it like this; what if you, as the short seller, filed for bankruptcy and can’t return the shares you borrowed?
Unfortunately for the broker, they must return the shares to the lender. And it’s because of this risk; you need to pay to play. However, you can take our stock trading course if you’re new and want to get a handle on things. Or as a refresher for anyone who’s a pro at trading.
How Much Does It Cost to Borrow a Stock?
- Here’s what it costs to borrow a stock:
- Choose the number of shares that you want to short
- Multiply the number of shares times the price of the stock
- This will be the cost of your negative position
- Then you would add broker commission fees.
What Happens to Me If the Lender Wants to Sell Their Stock?
As the renter or short seller, typically nothing. Typically the broker that loaned the shares out to the short seller will replace the shares from its existing inventory.
The shares are sold, and the lender pockets the proceeds. Now the short seller is responsible for returning the shares to the brokerage firm.
All that changes is who the short-seller is returning the shares to. We talk about short selling in our trade room. Make sure to check us out.
How to Borrow a Stock With Four Steps to Short Sell
- Contact your broker. You need to see if they have shares of the stock you want to bet against. Your broker will then find an investor who owns the shares and is willing to loan them to the brokerage firm, with a fee for the so-called “renting” of their shares. Unfortunately for you, you’ll have to foot this bill.
- Immediately sell the shares you borrow on the market. At this point, you will have cash in your pocket due to the sale.
- Wait. Wait for the stock price to plummet and then repurchase the shares at the new, cheaper price.
- You return what you borrowed. The shares return to the brokerage you borrowed them from, and you pocket the difference.
A Real Life Example of How to Borrow a Stock
Say company CAR; an automobile parts manufacturer is trading for $40 a share; way too high in your opinion. Plus bad news is circulating that a faulty sensor was the cause of fatal crashes on the highway.
You sense an opportunity here and contact your broker. Luckily, you have a great broker, and they can immediately find 100 shares from another investor and lets you borrow them. You quickly sell the shares and pocket the $4,000 from the sale.
Two weeks later, the company confirms the crashes were in fact due to a defect and the stock plummets to $25 a share. And what do you do?
You buy 100 shares of CAR for $2500 and give the shares back to the brokerage you borrowed from. Do the math, and you pocket a nice $1,500 profit. Not a bad return if you ask me.
What Is a Hard to Borrow Stock?
Beware of Hidden Fees
It’s a given, in life, there are always hidden fees. Even if they say there are no hidden fees, they’re there, just hidden somewhere else.
That said, let’s talk about the fees you have to pay to play. First are the interest and commission to borrow the stock your brokerage charges.
Second is the dividend you must pay. If the company pays out a dividend between the time you borrowed the stock and the time you returned it, it’s on you to pay it.
Choosing Your Broker Wisely
Choose the right broker or dealer to work with is essential. Brokers help you to search for the best stocks in the market for short selling.
They also help you to look for sellers who are ready for short-trading. It would require a lot of time and resources to search for such owners and still make a profit.
Always remember that you have a tiny window open for buying, selling and making some money. There are many brokers in the market, but you have to choose the best.
Your experience when borrowing stocks will depend on the skills of the dealer you have identified. Choose an experienced dealer who understands how the market works and is proactive to guide you through the processes.
Brokers charge for their work on commission. You need to choose a dealer who will give you the best rates.
Short selling is a matter of timing, and you must, therefore, make a substantial amount that gives you returns and helps you pay the broker.
You might also want to consider a dealer who allows you to pay once you have made a profitable sale. Such a broker or dealer is confident that his insight was helpful.
Approach a dealer who asks for upfront payment with caution. This form of trading is a bit risky and may even lead to a loss.
While the dealer is offering professional services, there should be an assurance that the advice given will make your borrowing profitable.
There is no such assurance if a payment needs to be made in advance. However, it is not apparent that a broker who allows you to pay later is offering quality and reliable services.
Do Your Research Wisely
Learn about the market and trading trends. You have to know the stocks you are targeting, when to buy, how to make money and the perfect time to sell.
They make it easy to acquire and sell off stocks at a profit. Prepare for the benefits you stand to reap and the losses you are likely to encounter.
If you conduct thorough research and make a move at the right time, borrowing a stock can be extremely rewarding. However, there is also an opportunity to make huge losses beyond what you can imagine.
Research also points at the number of stocks you can take to reap the rewards you are anticipating.
The performance of the company in the stock market will give you the green light to deal or to avoid it. This information tells you what other investors think about a particular company.
If a lot of investors are looking to short sell, you know that they are expecting the prices of these stocks to fall or rise.
If there are more investors interested in a particular stock, there are chances that it will be volatile. Depending on your approach to risk, this will be good or bad news.
Wrapping It up
If you are entering the market for the first time, you need to take it slow. Invest only when you are sure that you will make a reasonable amount.
Though trading is full of risks, you must not risk everything you own. Only risk as much as you are willing to lose when trading.
Be patient enough to learn the tricks that work when borrowing stocks and those that will cause you losses. It will get easier and more profitable over time.