You might have heard of people making profits out of shares that rise in value from the purchased value, but have you heard about people making money out of shares facing a decline in their value? Well, this is exactly where the concept of short selling comes in. Making profits out of stocks that experience a decline is known as short selling. But before you plan to dive into the short-selling world, you need to understand the associated risks so that you do not end up making losses.
Also, this kind of trading is for the experts as it involves advanced trading methods and has substantial risks associated. Want to know more about short selling? Read on to gain a quick understanding about this trading technique:
What is short selling?
A trading method called short selling is predicated on the falling value of a securities or stock. You may start investing with a small amount and sell it for more money. In general, a buyer who buys shares at a lower price and then unexpectedly witnesses a significant increase may make a considerable profit. The short sales are borrowed from another owner; they are not their property.
As a result, anytime a stock price declines, shareholders typically engage in short selling, investing in the stock for a few days until it rises. It should be emphasized that short selling carries the highest risks of any trading strategy. So, before investing in it, consider the risks. You can also brush up on your knowledge of the market, including Nifty metal index and other indexes.
Advantages of short selling
- It can get you huge profits.
- You do not have to pay a huge capital amount for investment purposes.
- It is possible to leverage investments.
- You can hedge against other share holdings.
Disadvantages of short selling
- If you run down into losses, the losses can be unlimited.
- Short squeezes
- Margin interest is incurred in short selling.
Strategies to keep in mind while short selling
Awaiting a breakdown while entering a trading range
The trading range is the range that varies between low price and high price range and can be traded during a specific period of time. When the price of the security breaks below the support level, it’s time to short-sell such securities because it is a clear indicator that the market is controlled by the bear. Also, a sharp decline is prone to be witnessed after the breakdown and thus it is always a good idea to short-sell the securities and wait for it.
Selling during an active decline period
When the price value of a security falls during a trading day and further closes down at a price that is less than the opening price, a decline occurs. But the reasons behind the decline may be variable and in such cases, you can consider short selling during an active decline to make the most out of such an opportunity.
Keep the short selling limited to bear markets
Short selling in a strong bull market is no less than swimming in an ocean against the tides. And, in order to make profits in such a market, you need to have some of your stars and luck favoring you. Thus, it is always advisable to short-sell in the bear market because it comes once and also shows an upward trend.
Minimizing the risks
When you short-sell, you may come across companies whose stocks face an increase or decrease without any logic. You can even see the stocks of poor performing companies facing an upward trend for no reason. And, traders who practice short selling end up buying more of such stocks to get themselves covered.
In addition to this, this approach further pushes the price of the stocks higher than the expected value and triggers protective stops besides creating gaps. Make sure that you buy such stock with great discipline. Also, ensure to use the stop loss order and keep an eye on the same so that you can keep adjusting the stop loss to either tighten the stop loss price or to make good profits out of the short selling trade.
Understanding short selling appears to be successful in the near term. But occasionally, it looks daunting as though the majority of people don’t utilize this strategy. Short-term selling is difficult because individuals prefer long-term trading and avoid it because of the increased risks involved.
Additionally, experienced traders who have greater knowledge about market are advised to utilize this approach; yet, for beginners, it is completely inescapable. Besides, if you use the right tactics and keep this stop loss in place, you can get bigger profits. However, be cautious of the market before investing in short selling.