Securities Short Selling: Understanding the Basic Concepts about Short Selling
In an investment plan, you will come across many investment platforms and criteria that are all aimed at multiplying your invested principal. But as an investor, you need to be aware that you need to get everything right for you to realize a profit on your invested principal. Short selling is one of the popular investment and trading criteria that you can use to take advantage of decreasing market prices.
Short selling has always proven to be a profitable investment plan for many investors. As an investor, you can get the best from this investment plan when you get it right.
What is Short Selling?
Before you venture into s Short selling, it's always prudent for you to fully understand it and how it operates. We can define Short selling as a practice of buying some investments with a prediction that the market price is going to rise to a certain limit. After some time, you may also predict that the price may fall at a certain price, thus; selling the assets at a price that will give you any profit. If you short sell your assets, it means that you have a prediction that the price of such assets is going to drop below the invested amount, and you decide to make any profit from your position.
As a short seller, you should behave like someone who is betting. You can short sell your position at a higher price, and right after the price falls, you can still buy it at the lower price. The difference between the buying price and the selling price is your profit as a short seller.
As a short seller, you can also borrow shares that you are not the owner of and sell them to a different investor. You can do this in agreement with the one you borrowed from that at some point or after a specified time-frame, you will return the shares you borrowed to him/her. You can do this if you predict that you will be able to buy the borrowed shares at a lower price than the one you sold at.
Why Should I Short Sell?
As a short seller, you can be motivated in two ways that will push you to accept the short-selling idea. The two factors include;
Hedging- this is a way of insuring your investments against the drop in price as predicted to the future. You can short sell your shares by strategically using the marketing tools to analyze the risk of holding the shares that will drop in price in the near future.
In a technical way, for you to hedge, you need to make offsetting trades in securities that have negative correlations.
Speculating- the speculations may push you as a short seller to short your assets to profit from an overpriced market. As a short seller, you may be motivated by speculations that if you sell your shares now, you will buy them in the future at a price lower than the one you sold them at.
Pros and Cons Involved with Short Selling
Short selling comes with its advantages and disadvantages. It can be highly advantageous when you predict it right and can be costly if you guess it wrong. Here are the pros and the cons involved with short selling;
· There is a possibility that you will make high profits
· You require little or no money to start short selling
· There is a possibility that you will get a leveraged investment
· You can easily hedge against other holdings
· There is a potential for an unlimited loss
· It is necessary that you have a margin account
If you come to a close position, as a short seller, you might have trouble finding enough shares to buy in case many other investors and traders have shorted their stock. If you put all your investments in the short-selling basket, you may also be caught in a limited time frame when a certain stock decides to sky-rocket.
On the other hand, short selling can be a lucrative way of investing. Short selling is one of the strategies that offer high risks but translates to high returns. If you predict it correctly, you can make a tidy Return on Investment (ROI).
Risks Associated with Short Selling
Apart from you as a short seller making a loss from the falling of the stock’s price, there are other risks that you need to analyze before venturing into short selling.
Timing- timing is a key risk that many short sellers should keep in mind. During the time of investing, the company may be overvalued, but it may take a long time for the said company’s stock price to fall. You will be subjected to interest, being called away, and even the margin calls during this time. As a short seller, you need to be careful with timing to make sure you get it well.
Borrowed Money- margin trading can be the best term to refer to short selling. With margin trading, you, as a short seller or investor, are required to have a margin account that you can use to borrow money from your specific brokerage company by accepting your investment to be used as collateral.
In case you go wrong with your prediction in the stock market, you may end up being subjected to a margin call or be required to fund your investments or liquidate your investment position.
Regulatory Risks- you may plan to short sell certain stock in a specific sector, and the regulatory bodies ban short sales in that sector. This may force you to as a short seller to cover short positions at huge losses.
Investing Against the Trend- the history of the stocks is that they always appreciate at a price. Shorting in the stocks sector is a bet against the normal trend that there may be inflation and the price of the stocks depreciates instead of appreciating.
As an investor who wants to engage in short selling, the above are the risks that you should analyze before engaging in such investments. If you analyze such risks and cover them, you will reap highly from engaging in short selling.
How Can I Short a Stock?
Investing in short selling may prove to be risky but gives you wonderful returns. Investing with short selling is simple and straightforward.
Here is a simple process to follow;
1. Analyze the stocks available in the market to predict how they behave in matters of price and demand. You can use the available analysis tools.
2. Open a position that will allow you to sell the stock. You can do this either through a derivative or a broker.
3. Keep watch on the market trend.
4. Purchase the stocks back at the new market price. This price should be lower than the selling price.
If you correctly predict and the stock will fall in value, you can close your position and the difference of the selling from the buying prices with making your profit.
Short selling is a practice that most investors often use for stock trading and can also be used for others. This practice enables you to take a position that the asset is going to fall in price, and you can buy new stocks with the aim that the price will rise above the price that you bought them.
It is important to manage your short-selling risk with the orders that can stop the losses. This way, you can reap highly.