What is a Short Sell in Stocks?

The financial market, just like any other market, is working because someone wants to buy something, and someone wants to sell it. But in food or goods markets you can only sell things you own. The same goes for most of the brokers, you can’t sell what you don’t have. And why would you even need this? From this article, you will know, how to earn, when others lose, and how to become a bear. Now you will learn to short sell!

What is short selling?

How’s that even possible to sell something you don’t have? Well, some brokers, like FBS, allow you to use your deposit like you have assets instead of them. To make things clear, let’s go through the short-selling process step-by-step.

You made the analysis and now you are waiting for the price of the asset to fall.
Broker lends you the asset (for example let’s take some random stock, like ALCOA) at the price of $51.5.
You sell the share for $51.5. Now you have no stocks available but do have a 1 Alcoa share debt that should be bought back sooner or later.
ALCOA falls to $49.
You buy the share back for $49. Now you don’t have any debts, and your profit is $2.5 for each stock you have.
Congratulations! You have made profit short selling stocks!

So once again: you goal is as usual to buy low and sell high, but with short selling you do it in reverse order: firstly sell and then buy.

Why do I need to short sell?

There are several reasons for you to consider short-selling stocks. The first and the most important is that no asset grows forever. The economy has cycles and at some point, there won’t be any growth in shares. With weak indices and the understanding of future downtrend movement why not short sell?

Another reason for short-selling is a hedge of your risks. Let’s say, for example, that you have enough opened long trades, and you think that markets will rise in a month or two. But also, you think that some plunge may occur in the next hours. It’s much wiser to short sell rather than close your long position and re-enter lower because trading is a probability game, and the price may surge against your forecasts.

Note that short selling is different from regular investing because you need to have access to leverage and margin trading if you want to short sell. Investing can be done without any leverage, thus, there are no risks that your position gets closed automatically when margin levels are critically low.

What are the risks of short selling?

If the investor bought one Alcoa share at $51.5, the maximum they could lose is $51.5 because the stock cannot drop to less than $0. In other words, the maximum value that any stock can fall to is $0. If an investor shorts a stock, there is technically no limit to the amount that they could lose because the stock can continue to go up in value indefinitely. In some cases, investors could even end up owing their brokerage money. Good for you, FBS will never act like this. Control your risks and you will never see a loss of the whole deposit at once.

While short selling does present investors with an opportunity to make profits in a declining or neutral market, it should only be attempted by sophisticated investors and advanced traders due to its risk of infinite losses. Short selling is not a strategy used by many investors largely because the expectation is that stocks will rise in value. The stock market, in the long run, tends to go up although it certainly has its periods where stocks go down.

To sum up, it’s amazing to have means that allow you to earn money on every movement in the market. This way volatility is the thing that matters the most. The only thing you will need is to predict the future price movement. But be aware of risks and always maintain sufficient funds in your account, or the broker will have to close your position automatically. The history remembers cases of Short Squeezes (an article about them will be released shortly), events when the price of the stock skyrockets because of the unusually high interest for the stock and an enormous number of short-sellers, that are closing their positions in awe of horrific losses.

Author: FBS Analyst Team

More by this author

Similar

21.08.2023 13:00 Imbalance Trading Strategy

This article introduces you to a trading strategy that doesn’t require volumes, technical indicators, and price patterns. All you need to do is to be attentive to the price action. Welcome to the Imbalance tutorial.