Let's say you buy a stock. You buy it for $10. You sell it for $11. Your gain is $1, and $1 divided by $10 is a 10% return on your money. Conversely, let's say you short a stock at $10. It drops to $9. You buy it. So you've made $1. I think you profit there would be 10% too - again $1 divided by $10. But $10 is the sales price, not the purchase price. Is that right? It might be a stupid question, but I just want to make sure I'm doing my calculations right. It can make a huge difference. I don't know if maybe the way short sales and margin and what not works mean in my short sale example above it should instead be $1 divided by $9 to a greater than 10% return. Thanks!
$10 either case is your entry price. Don't think of direction. Just where you entered and where you exited and the difference between the two. As you thought 10% whichever.
Thanks Suntrader. That makes the most sense - whether you are short or long, the broker is going to calculate the funds available in your account, margin, etc. based on what you got in (your entry price), whether its a buy or sale. Thanks!
One method to normalize metrics for returns is to use return on risk capital. A method of quantifying risk is 2X the shorted price, another is to use risk associated with at 2 STD Dev move. In your example the two would be close: risk is (20 (2X short price) - capital from the short)=10 which comes out to your 10% return for both cases. -- Note: Some products may not have symmetrical risks, however, such as some of the short volatility products. {I did not include detail on the 2 STD DEV move, which may be similar handling to a PM account approach}
You did not consider the case where the price goes nowhere. In most cases, the price goes in a zigzag messy chaotic erratic sluggish undecisive spiky-pokey twist-here-and-there manner. When you try to long or short such a stock, it will most likely be unprofitable.
Yes you have it correct OP. But keep in mind there will also be a cost-to-borrow fee charged when you short a stock that isn't there when you long it. Sometimes that fee can be significant,other times it's tiny and not worth concerning yourself with. Probably 75% of my trades are short plays.
r =( new price-old price)/old price (In simple terms) Note that when you short, margin will also reduce, so return on margin changes
either direction, long or short, your initial investment still remains the same + the gain added to your initial investment is also the same amount in either the direction, ($1 dollar in this case * # number of shares) (if your guesses are correct), but on the short side, if you don't pay attention, then you'd pay back the dividend to the buyers. you ain't get that 1$ gain 100%