What Is Short Selling?

What Is Short Selling?

If you have reasons to believe that the market will go down, you can make money by shorting that market. Short selling (also known as shorting or shorting the market) means that you sell the market first and then try to buy it later at a lower price.
It’s exactly the same principle as “buy low, sell high”, only in the reverse order – you sell high and then buy low.
You may be wondering how you can sell stocks before buying them? It is actually not as difficult as it seems. To sell a stock that you don’t own, for example, you must first borrow it. Your broker facilitates this process and may allow you to borrow shares that are owned by another trader or, more often, the broker itself.
When you are ready to exit your short position, you cover the position by buying back the shares that you have shorted. In other words, selling before you buy really means that you borrow the stock before you sell it short.
This discussion is meant to be a simple introduction, not a comprehensive education to fully prepare you for shorting the market. Before shorting the market, talk to your broker about the risks and rules of short selling and educate yourself in all the details. Also, be aware that the rules for shorting a stock may be different than shorting a futures, spot forex, or other market. Talk to your broker for details.

What makes short trading so exciting
Selling first and then buying later (and hopefully at a lower price) has many advantages, including the following:
> Markets tend to go down faster than going up. This is because fear is a stronger emotion than greed. When people get scared, they tend to get out of their long positions quickly and widely. Markets can go into free fall, and so it is generally possible to make money faster by shorting rather than buying, at least for short periods of time.
> By being flexible enough to sell short, you unlock your ability to make money in different market conditions. When you feel comfortable with short selling, you provide yourself with more opportunities to make money.
> Short selling options can provide a hedge against your long positions. Options are contracts that give the owner the right, but not the obligation, to buy or sell a stock at a certain price before a certain time. It is much less expensive than buying the stock itself, and therefore, it can act as a kind of insurance policy against the stock position.
Taking a short position on a stock with an option actually involves buying a put option. This may seem a bit confusing because you have a short exposure to the stock as the value of the put option increases as the stock price moves down.
The advantage is that you pay a small premium, which can be considered as a deposit that allows you to sell the stock at a higher price if the stock goes down.
Hedging is like buying insurance. Doing a trade helps offset the losses that you may incur in a major position.

Short selling challenges in the market
Like most things on the market, and in life, there are two sides of a coin. If you decide to incorporate short selling into your personal trading, it is important to be fully aware of all the implications.
Short selling also has several drawbacks that you should seriously consider:

  • It may feel unnatural, and you may struggle to get around the concept. He may be psychologically difficult and feel uncomfortable with you.
  • Selling is more expensive than buying. When you short sell shares, you borrow the stock and have to pay a fee, albeit a symbolic one, for doing so.
  • In theory, short selling has unlimited risks. If the market moves against you (by going up), there is no ceiling to how high the price can go.
  • It may be unpatriotic to take a stand against a successful business and/or economy.
  • Not all stocks are available for short sale, and some of those stocks are not always available. This reduces the realm of stocks available for you to trade.
  • The short sale must be done in a margin account. It is up to you to decide if you are comfortable trading with borrowed money.
  • If you sell shares when the company pays dividends, you will owe the dividend and it will be withdrawn from your account. Remember, when you short sell a stock, you don’t own it. You are borrowing it from your broker who still owns it, so he will want to pay dividends if you hold the short position when the company issues a dividend.
  • If a company rotates part of its operations, creating two companies, you may find yourself in a short position in both companies. This can be a problem if you are not strict with both companies.