Short trading or short selling is an established form of trading that millions of traders use to their advantage every day.
But what does short selling mean and how can you apply it to a feasible investment strategy? Read on to find out.
What is Short Selling?
Typically, when investing in a stock or other financial instrument, your goal is to buy cheap and wait for the stock to increase in value before selling it for a profit. That’s the type of trade most people associate with investing.
But what if you thought that a stock would decrease in value, is there a way to profit from that?
As you’ve probably guessed by now, there is. It’s called short selling, and it’s a way to trade on a market in decline.
Without getting too technical, a short stock trade involves a trader borrowing a stock from a broker with the intent of buying it back for a lower price in the future.
The concept is based on the fact that you can buy and sell an asset that you don’t actually own, before buying it back and repaying the loan. It’s sort of like regular trading but in reverse.
This form of trading has been becoming more popular with since smartphones and apps will allow for very flexible trading.
As with all sorts of trading, short selling is not risk-free, and you should really know what you’re doing before getting started.
Reasons Why People Short Sell Instruments
There are two main reasons why somebody might want to short sell a stock.
- Analytical Work
Seasoned stock traders spend many hours every day looking at charts and analyzing assets with the hope of finding a pattern worth investing in. Most of these traders focus on finding signs that an asset is about to increase in value, but sometimes they stumble upon the opposite. And if the signs are strong enough and the trader is confident that the asset will drop, he or she might short sell it.
- Hedging
Moreover, short selling is also used for hedging and to add variation to a portfolio. By short selling the right assets while also placing regular investments in other assets, a trader can limit some of the risks and potentially make extra profit.
In certain cases, short selling can be used to make a lot of money quickly. For example, if a company ends up firing a CEO or ends up in a massive scandal, the stock will most likely plummet, creating a great opportunity to cash in. The same goes for market crashes, where experienced traders can try to make a quick buck before the crash levels out.
How To Short Sell As a Strategy
Short selling as your only strategy is rarely advisable because of the simple fact that it’s slightly more complicated and can be extra risky at times. That being said, short selling should always be a part of your overall strategy, and you shouldn’t be scared of doing it when an opportunity presents itself.
That being said, there are professional traders that short sell more than they invest and they do just fine. Just remember that most investment guides and trading strategies aren’t based on short selling, so you will have to adapt your work accordingly.
