When you short stock, also known as “short selling”, you bet that stock’s value will go down. It is the act of selling something that you do not own, where you need to borrow your broker’s shares of stock. As intriguing as this might sound, you should first know some important things to make this trading strategy work.
Before You Short Stock
If you see the general stock market being in a downtrend, you should not be buying stocks. However, you still need to make money, and this is where art of shorting comes in very handy.
Generally, the public only plays the long side of the market, and what they do not realize is that they can make money when stocks are down. People usually think that it is good if a stock goes up, and then it is bad if a stock goes down, which is not entirely correct. As you can see, it really depends on which side of the market you are on—long or short. In some cases, you can make money faster by shorting a stock than buying. The reason for this is that stocks typically go down at a faster rate than when they go up.
When you learn how to short stock, you can also get a better understanding of where reversals are going to take place. This means that you will be able to gauge where other traders would go for short selling and covering their positions. In fact, when you hear stock exchange professionals talking about how bad the market is, they might be encouraging investors to sell and then short stocks to gain profit all the way down.
Useful Tips on Short Selling
In order to start shorting a stock, you should first open a margin account with your brokerage firm, where you will be charged interest on the funds that you are going to borrow and will be subject to rules and regulations that govern short selling.
Then, look for a rally into the Traders Action Zone, which is a buy-and-sell zone on a stock chart used by swing traders to determine possible stock reversals, instead of waiting for a pullback. If stock prices rise, then you will have to buy back the shares at their new prices and personally absorb the loss. Take note that, unlike in a regular investment, where a loss is limited to the amount of your invested capital, the amount of losses in shorting a stock does not have any limit to it.
Also, short selling is a good way to protect your portfolio, though this is not recommended if you are an individual or an institutional investor.
There you have it! Once you start shorting a stock, you will gradually get more comfortable with it. By taking these tips into consideration, you will soon realize that this trading technique is actually good to use. It will make no difference whether you are in a bull or a bear market, and you will be able to make money regardless of the direction you are taking.