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    What is short selling and How to Master it

    What is short selling and How to Master it

     What is short selling?

    Short selling is an advanced strategy of trading stocks where you take advantage of a potentially declining stock price, you borrow shares from a broker, find another party that wishes to buy the shares from you, you sell them, then if the worth of those shares decreases you can buy the same shares elsewhere for a reduced price and give them back to the original broker you borrowed the shares from. The profit comes from using the money made from selling the borrowed shares to pay the reduced price for the same amount of shares to cover the ones you borrowed from the broker.

    Some key points:

    • Short selling happens when an investor borrows a security and sells it on the open market, planning to repurchase it later for less money.
    • Short-sellers bet on a drop in a security’s price and profit from it.
    • Short selling has a high risk/reward ratio: It can offer big profits, but losses can mount quickly and infinitely.

    A hypothetical example of how short selling works

    You borrow 100 shares from a broker (A). Say, the shares are for a wine company; these shares are currently trading at £10 each. You now sell these shares for £1000 to broker (B); you now have £1000 in your account but have to get the 100 shares somehow back to broker (A). So what should you do?

    Short selling is using market decline to make a profit. In this scenario, the wine company has run into trouble due to poor weather conditions. (which you may have been betting on due to recent weather and meteorology reports), slowing down their grape harvest and therefore slowing down their whole business and its ability to trade and sell wine, this would make the shares value worth less (say £5).  

    So now you must find someone to sell you these shares at the reduced price. Broker (C). You buy back 100 shares in the wine company for £5, this only costs you £500 total. You can now give the shares back to the broker (A) from which you borrowed. Thus leaving broker (A) with their shares. Broker (B) with the stocks they purchased from you for £1000. Broker (C) with the £500 you bought their shares for and YOU with a profit of around £500 minus broker rates and other potential fees.

    A man is present try to decide whether he will be shorting a stock or going long on the stocks.

    The Risks of Short Selling

    There is a risk. Losses can potentially be infinite. For example, you do all which is written above but switch the stock value movement around, so the shares of the business increase in value, you will lose money.

    This is because you have sold the borrowed stocks but now have to purchase them at a higher price than you sold them for so you can give them back to the lender! If the shares were worth 10 when you borrowed and sold 100 of them, and the market rises so the stocks are now worth £15 you now are faced with a dilemma as you only have £1000, but to cover the borrowed stocks it would cost you £1500, thus leaving you with a loss of £500….

    The loss is amplified by how much the shares change in value, they could rise exponentially driving your losses up with them. So this is the potential risk that comes with short selling.

    The difference between long and short

    When it comes to stock trading, long and short, refer to whether a trade was initiated by buying first or selling first. A long trade is initiated by purchasing expecting to sell at a higher price in the future, achieving profit. A short trade is initiated by selling borrowed stocks before buying, with the intent to repurchase the stock at a lower price and obtain a profit.

    When a trader is long, they buy an asset hoping its value will increase. More experienced traders often say they are “going long” or “go long” to indicate their interest in buying a particular asset. If you go long on 1000 shares of XYZX stock at £10, the transaction costs you £10,000. If you can sell the shares at £102.00, you will receive £10,200, and make a net £200 profit, minus commission.

     This type of scenario is preferred when long selling. The alternative is that the stock drops. If you sell your shares at £99, you receive £99, back on your £100,00 trade. You lose £100, plus commission. When you go long, your potential profit is unlimited since the price of the asset can rise indefinitely. If you buy 1000 shares of stock at £10, that stock could go to £20, £50, £500, £1000, etcetera. Day traders typically aim to benefit from smaller market moves. The only risk is the stock going to 0, where it is worthless.  The worst-case possible is if the share price goes to £0, resulting in a £1 loss per share. Day traders keep risk and profits well-controlled, typically exacting profits from multiple small moves.

    Image shows Short Selling, in large blue letters, With a green dollar sign showing a downwards arrow and a semi circle gauge with the ticker over the red indicator.

    Key points of Short Selling :

    • Short selling happens when an investor borrows a security and sells it on the open market, planning to repurchase it later for less money.
    • Short-sellers bet on a drop in a security’s price and profit from it.
    • Short selling has a high risk/reward ratio: It can offer big profits, but losses can mount quickly and infinitely.

    Here is some more info on short selling from other websites check them out they have some useful stuff!

    Investopedia- https://www.investopedia.com/terms/s/shortselling.asp

    Firstrade- https://www.firstrade.com/content/en-us/education/margin/marginshortsell

    Want to make Money Online Easily? Why not just copy me and my trades?

    My name is Joseph Moricca and I run Velox Investments and I am a Popular Investor on eToro. I utilise short selling as part of my Investment strategy that has generated over 50% ROI in 2019. If you want to find out more feel free to have a look around the site. If you want to find out how to make money online then read my Beginners Guide to trading on eToro. Or if you feel ready you can join below!

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