How to Short a Stock on TD Ameritrade (Now Charles Schwab)

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Contributor, Benzinga
October 3, 2023

Short sellers often get a bad name in the market, but selling stocks short is necessary for any healthy market. Short sellers can often be the first ones to sniff out questionable accounting practices or misleading statements from management. But short selling is also extremely risky and requires a lot of diligence, timing and luck. Here’s how to short a stock on TD Ameritrade (now Charles Schwab).

How to Short a Stock on Charles Schwab

The first thing you’ll need to short a stock is a margin account with sufficient capital at your disposal. Margin accounts enable traders to apply leverage by borrowing money or shares from the brokerage. To qualify for a margin account, you’ll need to keep a minimum of $2,000 in your account at all times.

You’ll also need to maintain specific margin requirements for the equity in your account. At Charles Schwab, this rate is 30%, meaning you must have at least enough funds to cover 30% of your total position. If your margin account drops below this 30% threshold, be prepared to face a margin call. If you can’t meet the margin call, Charles Schwab could liquidate your position for a loss without informing you. Here are the steps to get started on a short position

1. Identify a Shortable Stock

Your first step is to develop a thesis on a stock to short. What headwinds are different companies and industries facing that could cause their stocks to decline? You’ll need to consider the economic environment and the individual performances of the companies you’re looking at. For example, tech companies have been popular targets for short sellers since interest rates have made the cost of borrowing capital more expensive. Come up with a trading strategy and execute it, just like you would if you were buying a stock for traditional investment.

2. Make Sure Charles SchwabHhas Shares to Borrow

Not every stock has enough liquidity to be easily borrowed. Remember, a short sale means you borrow shares from the broker and immediately sell them on the open market. This process is often easier said than done because Charles Schwab must locate borrowable shares and lend them to you. The less liquid the stock, the harder it will be for the broker to locate shares, and hard-to-locate shares can be more expensive to borrow. Charles Schwab will not allow naked shorting, which is shorting stock without actually locating shares to lend out.

3. Borrow Shares From the Broker per the Guidelines

Use your stock trading plan to figure out how, when and how many shares to borrow from the broker to sell short. The actual short sale of the stock will be free from commissions, but you’ll still need to pay interest on margin if you’re using borrowed funds. For example, if you borrow $5,000 to open a $10,000 short position, you’ll be charged an interest rate on that borrowed $5,000. Usually, Charles Schwabcharges a 7% to 9% interest rate on borrowed funds, and these costs must be factored into your overall gains and losses.

4. Sell Shares on the Exchange

When the broker locates the shares, they will be borrowed (usually from another investor) and placed into your account. Once the shares are in your account, you’re free to sell them on the open market. Selling a borrowed stock has no commission attached, just like any normal buying and selling of stock on Charles Schwab’s platforms. However, you can’t cash out profits just yet.

5. Buy Back Shares and Return Them to the Broker

Once you’ve sold the borrowed shares short, you play the waiting game. Your broker will demand the shares back at some point, so the hope with a short sale is that the price has declined enough that you can repurchase the shares later and pocket the difference between the short sale price and the repurchase price. 

Buying back shares after they’ve declined to return to the broker is called short covering. Ideally, the stock will remain liquid during its decline so that enough shares can easily be repurchased and returned. Once the broker has the shares back, the short position is closed and you’re free to cash out any profits.

How to Choose Stocks to Short

Choosing stocks to short is the hardest part of shorting. Even poorly managed companies can have their stocks appreciate in value over long periods of time and completely negate the profits of a short sale. Like buying options, short selling isn’t just about finding the correct companies but also getting the timing of the trade right and having good order execution.

Fundamental and technical analysis often can go hand-in-hand when looking for shortable stocks. Does the company have lots of debt and minimal earnings? Are there issues with accounting or production? And is the stock chart showing a downtrend that has momentum? Compare both schools of thought to narrow down the field of stocks to short.

Brokers for Short Selling

The Advantages of a Short Position

Shorting a stock can be a profitable endeavor, but there are other reasons investors short stocks as well. Here are a few advantages of holding a short position.

Profit off Unprofitable Companies

Many of the stocks that flew high during the COVID-19 pandemic were on unsustainable runs. Peloton Interactive Inc. (NASDAQ: PTON) and Zoom Video Communications Inc. (NASDAQ: ZM) are good examples. An investor who shorted these unprofitable companies as the pandemic began to wane saw huge gains if they timed their trade correctly.

Hedge Against Market Declines

Short selling isn’t just about speculation. Many investors will short certain stocks or exchange-traded funds (ETFs) to ensure their capital against bear markets. If you feel that the stock market may turn down, but you don’t want to unload certain positions and create taxable events, shorting a stock or index could protect your capital without needing an exit ramp.

Control a Larger Position

Thanks to margin, you can control a larger position than your actual capital would allow and enter a short position. If your trade is successful, you’ll enhance your profits without needing an extra infusion of cash.

Risks of Taking a Short Position

Short selling is risky and expensive, which is why most investors avoid it entirely. Even the most carefully laid-out short-selling plan can go awry if the stock price moves against you, and you may have difficulty unloading your position. Here are a few downsides of short selling to be aware of.

High Borrowing Costs

Margin isn’t free, and you pay interest on any capital borrowed from stock brokers. At Charles Schwab, these rates can be as high as 9%, so factor borrowing costs into your trade ideas.

Lose Money in Bull Markets

The last decade or so has seen one of the greatest bull markets in modern history, which creates a difficult environment for short sellers. Even the most suspect companies can find the cash to borrow for their operations at low rates. When the stock market is roaring, short selling is difficult to master.

Shares May Be Hard to Find

To complete a short sale, you must eventually buy back the shares you sold short and return them to the broker. But what if you can’t find enough stock? If shares are limited, other short sellers may buy them back earlier, which creates demand and pushes the stock price higher.

Short Squeezes Can Be Disastrous

The world became familiar with short squeezes during the GameStop Corp. (NASDAQ: GME) experience in early 2021. When a stock pops a large gain in a short amount of time, short sellers could face margin calls as their positions dwindle. This situation causes a rush to find and buy shares at a reasonable price to return to the broker. 

When buyers and short sellers are both trying to accumulate shares, the result is a feedback loop known as a short squeeze. A short squeeze is the worst nightmare for short sellers because a carefully developed trading plan can be made irrelevant in a matter of days or hours.

Have a Strong Trading Plan

Short selling stocks on Charles Schwab can be a useful strategy for investors, but it is important to understand the risks involved, such as the need for sufficient capital and potential margin calls. Careful selection of shortable stocks is crucial, and while shorting offers advantages, there are also risks to be aware of, including high borrowing costs and potential losses in bull markets. 

Thorough research, timing and risk management are essential when engaging in short-selling strategies.

Frequently Asked Questions

Q

Can you short on thinkorswim?

A

Yes, TD Ameritrade clients can short stocks using the thinkorswim platform. In fact, thinkorswim makes shorting easy.

Q

How do I short a stock?

A

To short a stock, you’ll need to find and borrow shares from a broker and immediately sell the shares on the open market. Then, after a price decline, you buy back the shares and return them to the broker, pocketing the difference in prices.

Q

Should you try short selling?

A

Short selling involves borrowing and selling shares with the expectation of buying them back at a lower price to make a profit, but it also involves significant risks. Before attempting short selling, it is important to thoroughly research and understand the market and the specific stock, and it may be advisable to consult with an investment advisor.

About Dan Schmidt

Dan has written about a wide range of topics including stocks and investing, cryptocurrencies, banking, student loans, and credit cards.