When most people buy an investment like a stock, they expect the stock price to go up. If the price of the stock is lower when they bought it than when they sold it, then they have made a profit. This process is called the "long" position. Short selling a stock or "short" as it is colloquially known, is the opposite. Instead of expecting that the price of an investment will go up in the future, people who go short expect the price to go down. How do you do this and how do you make money doing this? Read this tutorial to find out how to short sell.
Step
Method 1 of 3: Understanding the Theory
Step 1. Expect the price or value of an investment to fall in a short sell order
As mentioned above, going short is the opposite of going long. Instead of expecting that an investment will go up in value in the short or long term, you are basically hoping that the investment will go down in value.
Investors who have long positions want to buy at a low price and sell at a high price to maximize their profits. This is one of the maxims of investing. Investors who short sell basically want to do the same thing, except in a different order. Investors who choose to short sell want to sell at a high price and buy at a low price
Step 2. Understand that technically, you don't have an investment that you would short on it
When you place a trade for a short sell, for example, your broker will lend you a stock. Immediately, the shares will be sold and placed in your account. You will wait until the share price falls, at which point, you will buy back the same number of shares you originally sold. This is called "buy to close". The price difference between your initial selling price, even if you technically didn't own it, and your later buying price, is your profit.
Step 3. Look at an example to help in understanding
Assume that you, the investor, want to go short for 100 shares of Company XYZ, which are currently trading at $20. You contact a broker, who will then lend you 100 shares of XYZ stock, which you immediately sell. You now have $2,000 credited to your account, even though the funds were blocked because you don't own the shares and eventually need to buy the shares back.
- You will wait for the stock price to fall, because short selling means expecting the price to fall. After a disastrous 3rd quarter report came out, XYZ Company's stock price slumped to $15 per share. You buy 100 shares of XYZ Company stock at $15 to cover your initial position, which returns $1,500 to the person you originally borrowed the money from.
- Your profit is the difference between the price of the investment, when you sell and when you close it. In this case, you have sold Company XYZ stock at $2,000 and closed it at $1,500. You have made a profit of $500 by shorting Company XYZ stock.
Method 2 of 3: Understanding the Risks of Short Selling
Step 1. Be prepared to pay interest on your short positions while you wait to close them
Usually, you can hold a short position for as long as you want. However, because you borrowed the stock from a broker or a bank, you must pay interest on your position. The longer you hold on to the investment, the more you will have to pay interest costs. You don't think that you will get money for free, do you?
Step 2. Be aware that some short investors will be subject to a “call away” action
Sometimes, an investor who is trying to short a stock is forced to close it unexpectedly, because the broker who lent the stock wants to sell it. Remember that you don't own the stock you are trying to short, but you are loaned by a broker. If the broker wants to sell the stock before you want to, it's because there's an opportunity for them to make money, usually because the price is going higher not lower. Chances are you will be forced to cover an unprofitable position and lose money.
While call aways don't happen often, they're not unheard of. Call away actions are more common when a large number of investors are all trying to go short on a particular stock
Step 3. Know that going short carries a higher risk than going long
When you have a long position, you expect that the price or value of an investment will move up. If you buy 100 shares of JKL Company at $5 per share for a long position, your biggest possible loss is $500, if the share price falls to $0. Your profit possibilities are, well, endless, because there is no upper limit to how high the price of a stock will go up. In other words, there is a limit on the lower side and infinity on the upper side.
Short selling, as you might expect, is the opposite. There is a limit on the upper side and infinity on the lower side. When you go short sell, be prepared to deal with the possibility of "unlimited losses", as it is known. You can only profit from a limited share of how low the investment will fall. However, you will lose money on the share of how high an investment will go and investments like stocks have unlimited price potential
Step 4. Make sure that time is not working against you
Long position bettors often hold their investment for a significant period of time, waiting for the moment to sell it. Some investors even hold their shares for the rest of their lives. Short sell actors often do not have the convenience of that time. They often have to sell and then close very quickly. This is because they borrow their positions from brokers, so they work on loan time.
- If you decide to short sell, try to ensure that the stock price will fall in a short time. Set your own time limit with a backup time period. If the share price has not fallen significantly after the time limit and the reserve period, re-evaluate your position:
- How much have you paid the interest?
- How much loss have you incurred, if any?
- Do the same circumstances that led you to expect the stock to fall persist?
Method 3 of 3: Dive into the Intricacies
Step 1. Before you get into the game, do some research on the vital investment indicators
Short selling, as well as having a long position, is an investment. And people who invest smartly usually invest for a reason. Have a good thought about why you think that an investment will end badly. Take possession of any and all information that you can find, which either confirms or discredits your position. Don't do the research phase expecting to go short. Decide to go short after the evidence suggests it's a good idea.
- Share: When looking at vital stock market indicators, pay particular attention to future earnings expectations. This is the most important factor in determining a company's stock price. While future earnings are impossible to predict with precision, they can be "estimated" with the right information.
- Bond: Since a bond is also a security, it is also possible to short it. When determining whether it is appropriate to short a bond or not, pay attention to the yield of the bond. The yield is closely related to interest rates. When interest rates fall, bond prices will jump up, when interest rates go up, bond prices will fall. An individual who shorts a bond wants interest rates to move up and the bond price to fall.
Step 2. Do some research on the company's "short-term interest" before deciding to go short
A company's short-term interest is a percentage of the number of shares outstanding, which are currently in a short position. In other words, a short term interest of 15% means that 1.5 out of 10 investors are currently holding a short position in a particular stock.
- High short-term interest rates usually indicate that investors think a particular stock or bond will fall in value. It is likely to be a safer hope to short sell a stock or bond with a high short-term interest rate, although it is always risky to buy in general terms.
- On the other hand, high short-term interest rates may also make stock or bond prices more volatile. This can lead to a larger price swing than some investors are accustomed to.
Step 3. Be aware that closing a short can temporarily strengthen the price of an investment
This is an unintended consequence of short selling. When you short a stock initially, for example, the share price will move down because you are effectively selling the shares. When you buy the stock back to close it, the stock price will go up. If many people who are short on a particular stock decide to close it at the same time, the stock price will rise dramatically. This is called a "short squeeze."
Step 4. Recognize that when you hold a short position, you are responsible for distributing dividends and must cover any stock splits that occur
Stocks issue dividends to their shareholders, which is another advantage of holding long positions. If you short a stock, you must pay the borrower of the stock any dividends paid during the period you held it.
In the event of a split of shares, you are responsible for paying twice the number of shares at half the price. Investors' underlying position is fundamentally unchanged with a stock split, but keep in mind that when you close it, you'll be buying back twice the original number of shares
Step 5. Short sell as a hedge of the portfolio, not as speculation
If you short sell to speculate, you are likely to do so in a risky, unneeded way. Instead, go short as a hedge against large losses. As in futures transactions, going short can be an effective way of distributing risk across many different scenarios. If done carelessly, going short can end in dramatic losses.
Tips
- Holding a short sell position for a long time will cost more.
- Pay attention to the interest in shorting the stocks you want to short. If too many people try to short a stock, the stock will likely end up on the list of hard-to-lend stocks. If this is the case, you may have to pay more to short the stock.
