What is short covering in stocks/trading?
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Short selling is betting the stock will go down. Here’s how it works.
I have a feeling that Acme Biomedical will drop in value soon. So, I call up a friend that I know invests in the company, Wile E. Coyote.
I call up Mr. Coyote and arrange to borrow 1000 shares of stock for 30 days. The agreement is that in 30 days, he will have his stock back.
Right now, Acme is selling for $10 a share. That makes this stock worth $10,000. I sell it. All of it. I now have $10,000 in cash.
Over the course of the next few weeks, Acme stock is falling, like I knew it would. On day 29, Acme stock is selling for $5 a share. So, I purchase 1000 shares. This costs me $5,000.
I return the 1000 shares of Acme stock to Mr. Coyote. He has his shares back, and I have $5,000 in my pocket.
My purchase of the stock is covering the short, because I have to return it to Mr. Coyote. Of course, it’s a bigger issue if the stock price goes *up*, because I still have to cover the stock. If the price went up to $15 a share, then I’d have to buy the stock for $15,000 so that I can return it, and the venture cost me $5,000.
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