Short selling is a type of technique traders implement in the stock markets to make a considerable profit. Short selling can be described as the sale of a borrowed security by a trader who believes its price will decline in the near future.
The process of short selling happens as follows:
1. The trader borrows the stock from the broker
2. He then advertises that the particular company stock is for sale on the trading platform
3. Once he completes the sale of the borrowed stock, the proceeds are credited to the trader’s account, also known as the ‘margin account’
4. When the price of that particular stock dips below the current market price, the trader buys the stock and returns it to the broker
5. The sale price minus the purchase price is the trader’s profit.
The following steps can help a trader accomplish short selling:
1. Follow the Market Trend
When short selling, the trader has to follow and monitor the market trends. In short, the bear market is an opportune market to perform short selling. A market on a downtrend is also a good time for short selling. If there exists an upward trend, the trader should refrain from short selling as it is an indication that the stock’s price will continue on a definite rise before adjusting to its normal cycle.
2. Time the Pullback
Timing is essential for stock market traders. The pullback is a brief situation where the complete opposite of the upward price trend takes place. The pullback is a stall where rising prices stop at a certain point. This trend has two outcomes: a rise in price or a reversal in price. The trader can choose to repurchase the securities at the pullback level or can also bump into profits if the price spirals down.
3. Find the Big Players
If there is a breakout or a correction in the markets, the big players will continue to rise at least 20-25%, before the pullback happens. This pattern can also lead to a new pattern, and the chart can dip or rise. So the traders can minimize their losses by short selling those stocks that have already had a huge run as there is a possibility that these stocks will go on an extended and deep correction.
4. Be Aware of the Risks
Short selling traders should also be aware of the mathematical risks it carries. The most the trader has to lose is their invested money, but they can also make a considerable profit if the price of the stock plummets. At the same time, if the price goes up, the trader will not lose only their invested amount, but will also incur a heavy loss.
5. Greed is the Enemy
Selling short is a highly risky proposition that needs careful analysis and timing. Short selling only works during certain trends and does not last for longer periods. The market will also revert back to the upward trend and will never be in the same position. So, the trader should not get greedy, always indulge in a short sale, and should also hold some long positions of the stock to gain profits. When attempting a short sale, the trader should not make emotional decisions and should have a thorough plan to make profits from short selling the borrowed stocks.
As the old Wall Street saying goes, “Bulls make money. Bears make money. But pigs get slaughtered.” Short selling does not always guarantee profit for the trader. A trader has to be very cautious and experienced to short sell stocks as there is a possibility that the price of the stock will rise in the near future.