What is Short Selling?
It’s the opposite of Tall Selling.
Hilarious. Hardy har har. What’s the opposite of LOL?
All kidding aside, the idea of Short Selling is very simple: it means profiting from the decline in the price of an asset or a stock. Two-thirds of the time stock markets are on the rise; the other third, they are on the decline. Does that mean that you should cut your trading time to 66% overall? No, traders have a way to profit even in difficult times and crises provide opportunities for daily short traders. Do you understand why?
Yes, because they profit from declines in price. But how does it work?
If we think a stock is going down, we’ll short sell it. That means selling an asset we don’t have for a high price, so we can then buy it back for a lower price.
WTF? How can you sell something you don’t have?
Imagine walking into a store to buy a flat screen TV. The salesperson sells you a TV for $1,000 and promises to deliver it within a couple of days.
$1,000? I have a cousin who can get you the same TV for way less.
That’s great, but beside the point. After you pay for the TV and leave the shop, the seller calls his supplier and buys the TV for $900. In capital market terms he has performed a short sell on the TV – selling for more, buying for less. The same thing happens on the stock exchange, but instead of TVs we trade stocks, and instead of suppliers we have – well, smarty pants –
We have brokers?
Very good grasshopper! Now, let’s say a particular stock begins to fall below $35 and we want to take a short position on 100 shares. When we press the SELL button, we sell 100 shares which the broker has lent us.
Ok, and what did that get us?
We’ve sold 100 shares at $35 a share, so we now have $3,500.
Thank you Professor Calculus!
Let me finish. This sum of $3,500 doesn’t belong to us: our money is saved as a deposit, and we still need to give the broker his 100 shares back. Only now the price drops to $33 per share, and it’s time to realize our profit. We buy 100 shares at the lower price, $3,300 in total, and return them to the stock broker. And what do we have left?
$3,500 minus $3,300…one moment…five minus three…Hey! That’s a net profit of $200!
Correct. But it’s important to remember that you can also lose money on a short position. If you go short on 100 shares of a $35 stock and the price then goes up to $37, you can say bye bye to $200 out of your own pocket.
Darn, just as I was growing fond of them. So, does that mean that short positions are always more risky?
It depends. On the whole, stock prices go down more rapidly than they go up. So even though stock prices are more likely to go up than down (remember stock market prices go up two thirds of the time), once you spot a downtrend it is likely to be more robust than an up trend. The danger of short selling lurks for those who like to sleep, since you never know where the price will be when you wake up. That is why most short traders are day traders.
And what about short selling CFDs?
Well, CFDs are only more risky when you use leverage. Don’t like the extra risk, just use 1×1 leverage.
But isn’t short selling a way of profiting from the misfortune of others?
That is precisely what it is, and in fact, short sellers often get a bad rap for causing stock market crashes. But in fact they also help discover bubbles and burst them before they can grow completely out of proportion, which prevents others from investing and then losing everything.
Wait, so if it’s profitable and useful, why doesn’t everyone do it?
99% of investors doesn’t understand short selling and doesn’t not know how to do it. So most people lose money just as short trader profit – in times of crisis, when the economy collapses and inflation is out of control, the damage is taken out on our accounts.
And when can we expect one of those?
Hilarious. Hardy har har.