What is a Short Balance?
A short balance relates to the account of an investor who has sold short a company’s stock. Short selling is quite popular for many investors. An individual can open a trading account on margin, meaning the investor can borrow money from the brokerage house that buys and sells stocks for the investor. Short selling occurs when the investor sells shares of a stock he does not own, which effectively creates a short balance in his account. The investor hopes to make the money back by later buying shares to pay off this balance.
Short selling with stocks allows investors to make money by betting that a company’s stock price will go down in the future. As the stock price falls, the investor makes money. Stock price increases will reduce the investor's profit on the investment. Not all investors can trade on margin; it depends on their brokerage account and funds available to repay the brokerage house for the short balance. Shorting stocks is riskier than purchasing a stock because the potential for losing money is greater. For example, it is fairly unreasonable to think that a company’s stock price will fall to zero, meaning that the investor can sell the stock and limit losses.
Investors who short sell stocks can lose their entire investment if the company’s stock price goes higher than the original purchase price. This will create a significant short balance in the investor's account, meaning money is needed to pay off the brokerage house. While stop losses can help mitigate these losses, failing to act quickly can create a difficult investing situation.
Brokerage houses use basic accounting to track the short balance in an investor’s account. The total balance must equal the total numbers of shares outstanding multiplied by the original purchase price. Gains and losses are not necessarily posted until the short balance is rectified, i.e. the investor purchases stock to cover the short position. If the brokerage house decides to keep an updated account, however, it will post entries known as “mark-to-market.” These entries represent the change in stock price and will help the brokerage house keep tabs on the total balance owed by investors. When closing the account, any remaining debit or credit balance will represent money owed by or to the investor, respectively.
Brokerages houses will often put limits for margin accounts or the number of stocks an investor can short. Short selling stocks may allow investors to act unethically. Not only do they borrow money from the brokerage company in terms of a short balance, but they can manipulate the market by spreading negative rumors about the company with which they shorted stocks. This creates a profit through the resulting stock price decline.
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