What is Short Selling Stock and How is it Done?

So, in simple terms, the investor borrows a stock, sells it, and then buys them back to return it to the lender. The traders are betting that the stocks that they are selling are going to drop in price. In case the stock drops after selling, they will buy it back at a lower price and give it back to the lender. The profit he makes is the gap between the buying price and the selling price.

Short selling comes with significant risk. When an investor is buying a stock, they can lose the money they have invested. Hence, if an investor purchases a Tesla share at $625, the maximum amount they can lose is $625 as the stock can’t drop to less than $0. In simple words, the maximum value that a stock can fall to is $0.

Nevertheless, when an investor is selling, they can lose unlimited money as the stock price can keep rising. Like in the case of the previous example, if the investor had a sale short position in Tesla and the price increases to $2000 prior to him exiting, he would suffer a loss of $1325 for each share. So, selling short comes with higher risk.

To use a short-selling strategy, you need to follow a step-by-step process. This is what you have to do if you want to indulge in a sale short process.

Be advised, however, shorting requires paying interest on the shares borrowed for the transaction and the short interest rate can vary greatly depending on the equity. Below is an image of a short sale on the Webull desktop app.

Along with short selling explained here, a detailed understanding of the pros and cons of short selling stocks helps in deciding if it is right for you.

At its core, the strategy is making a trade that will be profitable when the asset price goes down. This is just the opposite of what you think when you think of investing or trading. You buy something, hold it for some time, and then sell it, hoping to get more than what you bought it for.

The particulars of short selling depend on who you are placing the trade through and the type of asset you are shorting.

Short selling comes with a large number of benefits.

There are however some problems with short selling.

Short selling isn’t a strategy used by several investors simply because they expect that the borrowed stock will rise in value. In the long run, the stock market tends to go up, but there are times when stocks go down as well.

For investors, particularly the ones looking at the long horizon, the purchasing of stocks is less risky than short-selling the market. Making money in short selling makes sense, only if the investor is sure that the stock will probably drop in the short term.

Short selling is used for hedging or speculation. Speculators use short selling for capitalizing on the prospective decline in a certain security or across the market on the whole. Hedgers use this strategy for protecting against or eliminating losses in security. Retail investors can capitalize on a short position if they personally feel that the underlying is overpriced or over-bought.

Savvy individuals and institutional investors engage in short-selling strategies at the same time for hedging, as well as speculations. Hedge funds are among the most active of short-sellers. Often, they use short positions in select sectors or stocks to hedge the long positions in other stocks.

While short selling presents the trader with the opportunity to make a profit in a neutral or declining market, it has to be attempted by sophisticated investors and advanced traders because of the risk of infinite loss.

So, short selling is much riskier than going long as there is no limit to the amount you can lose. Short selling should only be utilized when you are aware of the risks and have a proper strategy for risk management.

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