Selling price - Buying price = Profit per share
A lesser well-known method is "short selling". In this process, the order is reversed; an individual can first sell the stock and then buy back the stock at a lower price to make money. There are even more complexities behind this than buying stock, namely that one must borrow stock from someone else before he/she can sell it. However, the above equation still holds. One must sell at a higher price than you buy to make money.
Short-selling is known as a tough technique in the financial markets. Traditionally, it has been accepted as the counterpoint to long positions (buyers of stock), but the risks are even more nuanced;
1) A stock grow without bound (see aapl stock), but can only go to zero. Percentage-wise, you can only make 100% while long positions can make 100%+.
2) The ability to borrow to stock is not guaranteed. Depending on the broker and security of interest, one can might even have to pay a running fee to borrow (i.e. for hard-to-borrow stock). This is often the case when interest rates are low and there are many others who want to borrow. In fact, the business of borrowing shares at institutions is a division onto itself (e.g. securities lending).
3). many, many more...
Now, the upside is that short-selling can hedge other positions in an investment portfolio. Suppose you want to buy more stock but don't want to be long the "market" as a whole. Short selling can possibly hedge this (though this adds a different, basis risk). In addition, in a protracted bear market short selling is intuitively a good way to make money (vs. fighting the tide as a long-only investor)
But in the long run, is it worth it? Up until recently, I thought definitely so - there are plenty of over-hyped, expensive, and/or poor businesses which should not be highly valued. However, even I have underestimated just how difficult to make money in the long run:
(Source: http://www.valuewalk.com/wp-content/uploads/2013/12/Chanos-Performance1.pdf)
Above is the performance of the most well-known and perhaps the few surviving short-sellers in finance today. Jim Chanos survived multiple bull markets and even the technology bubble of the late 90s.
However, even he has only had an aggregate return of 2.1% vs. 12.7% for the s&p from the 80s to 2005. Keep in mind, this is the best of the best, the Buffett of short selling. Sure, on a relative basis he has done well (12.7- - 2.1 = 14.8% of outperformance vs. just shorting the S&P 500). But that's not problem - the problem is multiple 40% drawdowns in 93 and and 95.
If the best of the best can't beat treasuries but has far more drawdowns, it makes the entire method tough to justify.
Careful investing to all,
