Things To Remember While Short Selling
Betting on rising stocks always deemed to be a profitable business from the point of view of trading or investing but have you ever being thought that you can also earn or gain profits in short term while stock goes down. Yes it is true that you can also earn and you could see your portfolio increase in value during a bear market too? Many investors make money on a decline in an individual stock or during a bear market only with the help of using an investing technique called short selling. Short selling is not complex but the concepts of short selling are not so easy to understand, especially for investors. Generally investors buy stocks and hold it until it appreciates and make profit when it rises, while short selling is opposite of that, in shorting stocks investors make money only when a shorted security falls in value. However, short selling involves many unique risks and pitfalls because mechanisms of short selling are relatively complicated compared to normal transaction, so it is very important to understand how the whole process works before you get involved.
What is Short Selling?
Actually when an investor goes long on an investment, it
means that he or she has bought a stock believing its price will rise in the
future. Conversely, when an investor goes short he or she is anticipating a
decrease in share price therefore “Short selling is the selling of a stock that
the seller does not own. More specifically, a short selling means the sale of a
security or any individual stock that is not owned by the seller at that point
of time, but he promises to deliver it at time of delivery is called short
selling”.
Reasons to Short
Usually there are two reasons behind the short selling, one
used either for speculation or other for hedging. Let us discuss that where
short selling used to speculate and where to hedge and also what are the
restrictions to be followed while shorting stocks.
Speculation: Despite the negative perception on short
selling speculation is done while watching the fluctuations in the market in
order to quickly make a big profit of high-risk investments. However,
speculation involves a calculated assessment of the markets and taking risks
where the odds appear to be in your favor. Actually speculators can assume a
high loss if they use the wrong strategies at the wrong time, but they can also
see high rewards if they speculated correctly.
Hedging: Short selling is also used by most of investor for
Hedging. Hedging involves taking an offsetting position in a derivative in
order to balance any gains and losses to the underlying asset. Hedging can be a
benefit because you're insuring your stock against risk, but it can also be
expensive and a basis risk can occur. The majority of investors use shorts to
hedge. This means they are protecting other long positions with offsetting
short positions.
Restrictions: However, short selling is done whether for
speculation or for hedging but there are certain restrictions have to be
followed by the investors. The main restriction of short selling is that you
can place order within specified size, price and type of stocks in which you
can short. For example, penny stocks cannot be sold short, and most short sales
need to be done in round lots. There are certain restrictions placed to prevent
the manipulation of stock prices.
Risk Involved in Short Selling
Short selling is good to make profits in short term but
short selling is also very risky bet because there are some unique risks
entails like it is a pure gambling the losses can be infinite. Short selling
can also make you bankrupt because money used might be from borrowings and
short selling required to submit margin money with the broker. Lastly, short
selling also works when it has been done with right timing because even
selection of asset for short selling correct but if the timing is not suitable
you will not be successful.
Conclusion: In a brief, short selling sale means an investor
borrows shares, sells them
and must eventually
return the same shares (cover). Profit (or loss) is made on
the difference between the prices at which the shares are borrowed compared to
when they are returned. An investor
makes money only
when a shorted security
falls in value. In fact short selling can be also used for adding some
more profits to your portfolio
in downside or bearish market.
This is suitable if it fits with
your risk tolerance and investing style. Short selling provides a sizable
opportunity with a hefty dose of risk. We hope this tutorial has enabled you to
understand whether it's something you would like to pursue from the short
selling.
