What is Short Selling? How to Short Sell & The Risks.

How can you use short selling to protect your trading positions and profit in bear markets?

Short selling is a process where an investor sells a security they do not own and hopes to buy the same security back at a lower price to have a profit.

Short-selling can be done with stocks, options, and other securities. Shorting is often used to bet against the market or individual stocks.

This article will discuss short selling in detail and how it works!

What is Short Selling? How to Short Sell & The Risks.
What is Short Selling? How to Short Sell & The Risks.

What is short selling?

Short selling is an investment strategy that allows investors to benefit from downward price movements in a security. To do this, the investor sells the security first and then buys it back at a lower price later. The difference between the two prices is the profit.

The meaning of Sell Short

The meaning of selling short is to sell a security you do not own and hope to buy the same security back at a lower price so you can make a profit. Shorting is also known as going short or taking a short position.

For example, an investor who believes XYZ Company stock will go down in value may “sell short” 100 shares of XYZ Company stock.

What is a short-seller?

A short seller is an investor who bets that a stock will decrease in value. Short selling is often used as a hedge against an investment that has already been made or as a way to profit from an anticipated decline in the price of a security.

Short-sellers typically borrow shares of the stock they hope to sell from another investor and then sell the shares, hoping to buy them back at a lower price so they can return the shares to the original owner and pocket the difference. If the price of the stock does indeed decline, the short seller will profit. However, if the stock price increases, the short seller will incur a loss.

Short selling is a risky strategy and is not suitable for all investors. Before considering short selling, you should consult with a financial advisor to see if it is right for you.

What is a Naked Short?

The term naked short comes from the fact that the seller does not borrow the securities before selling them, as is done in a conventional short sale.

The risk of loss in a naked short sale is theoretically unlimited since there is no limit to how high the stock price can go.

In practice, however, broker-dealers must close out failing trades by buying securities on the open market to deliver to the customer. They will not allow customers to short sell a stock if they do not have reasonably good faith that the shares can be borrowed.

A practical example of short selling

To short sell a stock, you borrow shares of the stock from somebody else, sell the stock, and hope the price falls so you can buy it back at a lower price and give the shares back to the person you borrowed them from.

Let’s say you think XYZ Company is overvalued and due for a fall, so you borrow 100 shares from your broker and sell them immediately at $50 per share. Now let’s say that XYZ’s stock does fall to $40 per share.

You buy 100 shares at $40 and give them back to your broker. Your profit on the trade is $1000 (100 x ($50-$40)).

Now let’s say that instead of falling, XYZ Company’s stock goes up to $60 per share. You buy 100 shares at $60 to give back to your broker, and you’ve lost $1000 on the trade.

Short Selling Risks

When you short sell a stock, you are essentially betting that the price of the stock will go down. If the stock price goes up instead, you will lose money. Short selling is, therefore, a risky proposition, but it can be profitable if done correctly. Before shorting any stock, make sure you do your homework and understand the risks involved. Use stop-loss orders to limit your risk.

A Real Example of short-sellers losing.

It is not uncommon for a stock to be “shorted” by investors who believe the stock price will fall in the future. However, sometimes these short sellers can be caught off guard when the stock price unexpectedly rises.

One example occurred with Hertz Global Holdings, Inc. (NYSE: HTZ). In late April 2020, shares of Hertz rose sharply after the company announced it would raise $500 million through a new debt offering. This news caught many short-sellers by surprise, leading to heavy losses.

According to data from S&P Global Market Intelligence, there were 26.85 million shares of Hertz sold short as of April 30th, 2020. This means that nearly 27% of all outstanding shares were being bet against by short-sellers.

One month later, Hertz canceled raising new debt and filed for bankruptcy. Ultimately the short-sellers were correct but too early. Market timing was the problem that cost them heavily.

While Hertz is just one example, it serves as a reminder that short sellers are not always right about a stock’s direction. Sometimes, even the most bearish investors can be caught off guard by positive news. As such, it is important to always do your own research before making any investment decisions.

The Major Risk of Short Selling is Market Direction & Timing.

The default direction of the stock market is up. So betting against a company stock by short selling when in a bull market is extremely risky.

The other big risk is the potential for a squeeze. A short squeeze happens when a stock starts to rise sharply, and short-sellers are forced to buy the stock to cover their positions. This buying can drive the stock price even higher. Short squeezes are often associated with stocks that have been heavily shorted, and they can be difficult to predict.


Beat The Market With MOSES Index ETF Investing Strategy

Outperform The Market, Avoid Crashes & Lower Your Risk

MOSES Helps You Secure & Grow Your Biggest Investments
★ 3 Broad Market Index ETF Strategies ★
★ Outperforms the NASDAQ 100, S&P500 & Russell 3000 ★
★ Beats the DAX, CAC40 & EURO STOXX Indices ★
★ Fully Coded Scripts for TradingView ★
★ Buy & Sell Signals Generated ★
MOSES Helps You Sleep Better At Night Knowing You A Prepared For Future Disasters


Get MOSES Now


What is a Short Squeeze?

A short squeeze is when a stock price jumps sharply higher, forcing traders who had bet that the price would fall to buy the stock to cover their losing position. This buying can drive the stock price even higher. Short squeezes can happen in any market, but they are most common in stocks that have been declining for some time and then start to rebound.

When a stock starts to rise after a period of decline, some traders will bet that it is just a temporary rebound and that the stock will soon resume its downward trend.

Using Short Selling as Hedging

Hedging refers to the act of limiting your risks by making a trade that moves in the opposite direction to which you expect your stock to go. So if the stock moves against you’re other investment will decrease or limit your risk.

Example: Mary owns 100 shares of Google Inc at $500 per share, worth $50,000. She has already made a huge profit on the stock, but she fears the stock will have a temporary fall due to a bad earnings report. She decides to short her own stock. Mary opens short trade for 100 shares of Google Inc at $500 per share.

She is credited with the amount of $50,000 to her account by the broker, but she does not need to borrow the stock because she already owns it.

Mary now has $100,000 in her account. The stock moves down 10% to $450 per share. Mary closes the trade by purchasing the stock. Mary made $5,000 on the trade, 10% of $50,000. Her investment pot is now still worth $50,000. She has $45,000 worth of Google stock and $5,000 cash. This means that even though the stock she owned decreased in value, the amount of capital she has remained the same.

Mary could then invest this $5,000 in 5 more shares of Google, meaning she now has 105 shares worth $50,000.

Using Short Selling as Hedging

Hedging refers to the act of limiting your risks by making a trade that moves in the opposite direction to which you expect your stock to go. So if the stock moves against you’re other investment will decrease or limit your risk.

Example: Mary owns 100 shares of Google Inc at $500 per share, worth $50,000. She has already made a huge profit on the stock, but she fears the stock will have a temporary fall due to a bad earnings report. She decides to short her own stock. Mary opens short trade for 100 shares of Google Inc at $500 per share.

She is credited with the amount of $50,000 to her account by the broker, but she does not need to borrow the stock because she already owns it.

Mary now has $100,000 in her account. The stock moves down 10% to $450 per share. Mary closes the trade by purchasing the stock. Mary made $5,000 on the trade, 10% of $50,000. Her investment pot is now still worth $50,000. She has $45,000 worth of Google stock and $5,000 cash. This means that even though the stock she owned decreased in value, the amount of capital she has remained the same.

Mary could then invest this $5,000 in 5 more shares of Google, meaning she now has 105 shares worth $50,000.

Short Selling Summary

If you’re thinking of short selling, be sure to do your homework and understand the risks involved. It’s not a strategy for everyone, but it can be a profitable way to trade if you know what you’re doing.

Short selling can be a risky proposition, but if done correctly, it can be a profitable way to trade. Do your homework before shorting any stock, and always use stop-loss orders to limit your risk.

Have you ever short sold a stock? What was your experience? Let us know in the comments.

Related Stock Investing Articles:

LEAVE A REPLY

Please enter your comment!
Please enter your name here