Have you ever heard of short-selling or shorting stocks?
If you haven’t heard of shorting stocks and want to learn about it, this post is written with you in mind.
First, I must advise you that not everyone can utilize this particular method successfully.
What is short selling?
Short-selling a stock is done by borrowing shares and immediately sell them. Once the stock has increased in price, you then buy the shares back to return them to your lender and keep the profits.
It may sound a little confusing but that’s how it works. You sell first and then you cover it later once you see an increase in price.
Short selling is more difficult to understand, it’s more complex to manage, and it also asks for more responsibility in order to be successful at it.
Moreover, short selling stocks come with more risks; however, it does have a tendency to make more profits (Hence, it’s riskier).
But before you decide to start trading using the short selling method, you do need to have a good grasp on what you’re doing first.
Knowing how short selling works and the dynamics involved can assist traders in different market’s opinions to make more informed trading decisions.
This post provides you with some must-know information before you take the dive.
Short-selling requires a margin account
First thing first, you will need to have a margin account in order to short-sell stocks.
A margin account is a brokerage account that enables investors to borrow cash from their broker to invest. this loan comes with periodic interest just like any other type of loan.
It’s helpful that you should know that as well.
This account has a minimum balance requirement. Most firms require $2000, but they aren’t all the same.
Shopping around for your brokerage should yield many options.
Besides short-selling stocks, a margin account is advantageous in that it gives investors more buying power.
The more you can invest the higher is your chance of making profits. Who wouldn’t want to have access to more stock buying power anyway?
What are the risks of short-selling stocks?
Infinite loss: The amount of money you can lose going short is infinite. Not like when you go long and know first hand how much money you can lose if the market goes against you.
It’s simple and clear since you’re making profits when your stock goes down in price, then if some factors cause it to explode and become a very expensive stock, it’ll mean that you would lose a lot of your capital.
Even worse, if you don’t have the chance to stop your loss it can be a terrible investing experience, a nightmare that you can’t seem to get yourself out of.
You can’t be too sure: Short-selling a stock is the same as betting although you would conduct your research prior to that.
Hence, it’s not a new term in this market as many people refer to penny stocks as a game of gamble.
Everything may look like they’re on your side before you put your money in it, but once you acquire your position the unfortunate may occur.
With that being said, don’t believe that it’s easier to go short than going long.
in fact, it’s actually harder going short as the risk is heavier.
Stocks have an upward trend’s history in general: Just because a stock’s price moves up and down on a daily basis, it doesn’t mean that it’ll always remain the same.
history has shown that a stock is more likely to go upward than downward in prices.
Therefore, shorting a stock has less chance to make a profit than going long with a trade, historically speaking.
Spinoff risk: Ally bank has a great explanation for it bellow.
In the case of more complex events, like a spinoff or issuing warrants, the potential losses can mount even more quickly. Even though you shorted one security to begin with, you could actually become short two securities (or possibly more) at the same time. What’s more, both pieces could move against you. For example, if you were short Altria when the company spun off Kraft back in 2007, all of a sudden you would’ve found yourself short both of these firms and your trade suddenly became more complex to manage.
Should you short-sell shares?
To be honest I would never advise anyone to short-sell a stock because I know how risky it becomes once you’ve sold your borrowed shares.
But that doesn’t mean people aren’t making large profits from short-selling stocks.
Make your informed decision as to whether or not you should utilize this method.
It’s too much of a risk to be taken lightly.
Short-selling is one of the methods you can pick from to invest your money. it’s mostly used by investors who know what they’re doing.
If you’re new to stock trading, you shouldn’t try it until you become accustomed to the market.
Better yet, even if you may be well aware of what might happen to your capital if you fail with your strategies, it’s better not to take this dangerous chance.