Short selling is a practice that’s been and is still being
used by numerous traders in the industry. You might have heard it being said
within the financial community. But what does it really mean?
What is Short Selling?
Short Selling is the act of selling a security you do not
own or one that you have borrowed. Traders act on it in hopes of gaining profits
based on the belief that a security’s price will drop, allowing it to be bought
back at a lower price.
Usually, short selling stems from speculations or the desire
to hedge the negative side of losing a long position in the same security or
one related to it. Experienced traders who are familiar with the risks are
mostly the ones who use the method.
Pros and Cons
Advantages of Short Selling
- Large Profits: Just like with other derivatives, short selling offers you the opportunity to reap large returns without the need to risk as much money. The only money you give is the fee you pay your broker. If you make the right speculation and the stock price does plunge, the rest will be profits.
- Make Money in Bear Markets: Short selling is one of the few ways to make money even if the market sentiment is bearish.
- Hedging: Shorting a stock can potentially hedge your investment if you already own the stock, didn’t sell before the plunge, and if you think that it will be on its way to losing value. You can then short it to make profit from the remaining slump.
Disadvantages of Short Selling
- Limitless Loss: You can only make profit from short selling if the stock price ends up going down. But if you end up making the wrong speculation the opposite happens, then it’s possible for you to face limitless loss. Worst case scenario, if the stock skyrockets, you’ll then have to buy it at that price to return the stock to your broker.
- Market Crash: Short selling has the potential to turn a normal stock market dip and turn it into a market crash. It has worse implications for the stock market as a whole, which in turn means that the economy also faces bad repercussions.
- Bankrupting a Company: Numerous investors and hedge fund managers deciding to short sell the stocks of a certain company, all at once, can force that company into bankruptcy.
Test your skills in
stock trading at FSMSmart! We will
provide you with daily
market updates and help you stay up-to-date with economic events.
Register
for an account now!
