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Portfolio Management: Short Selling Method

John has just started investing, and one of his friends was mentioning how he could use short selling as an effective method to drive up his returns when the market started to go down. John decides that this idea is worth a try and decides to sell 100 shares of Stock A for $125 per share.

-What is John's maximum loss risk here, given this situation?
-Suppose Stock A's stock price appreciated to $135. What would his loss or gain be on this short sale at that point, if he placed a stop-buy to close the short sale?
-If John placed a stop-buy order when he made the original purchase for $130 a share, what would his maximum loss risk be in that case?
-What strategy would you use if you were just getting into short selling to avoid taking a big loss?

Solution Preview

The maximum loss is unlimited because the higher the stock reaches, the more loss it is for John.

If the stock price reaches $135 and he places a stop-buy order to close the short sale, John's loss will be $10 per stock ($135-$125) ...

Solution Summary

Discusses short selling strategy.