The world economy is trekking down a rough road. Production is plummeting, agriculture is highly uncertain and services are rising rapidly. So this has affected the Stock markets around the world, obviously. Many markets are experiencing Bearish trends. Keep aside the Bearish markets; are your stocks going down? have you made the wrong decision? Then Short Selling is probably the answer you're looking for. Now that I have your attention, let's dig in deep.
What is Short Selling?
As investors we know how to scrape profits out of the Stock markets. Buy a share at a low/er price hold it till the price rises and sell at a predetermined profit. This is the foundation of stock trading. But what can we do in a down turned market? Well, Short Selling says we can still make profits in a down turned market.
Short Selling is exactly the opposite of what we discussed above. In simple it's a trading strategy to make profits when a specific stock is decreasing in it's value or going down.
Long or Short?
When an investor invests in a share expecting the prices to increase in the future, it's known as investing for Long. On the other hand when an investor invests in a share expecting the prices to decrease in the future, it's known as investing for Short. Hence the word play Short Selling is derived.
The Process... How to Short Sell?
When an investor needs to Short Sell, his broker will lend the specific stocks to him. The stocks may be owned by the broker or another investor of the broker. It doesn;t matter since it's only lending. Then the investor can sell the stocks at the prevailing price. The amount will be credited to his account as usual. However the investor must buy the Shorted stocks again, that's only when the Shorting will be complete. So after some time, when the stock prices have gone further down, the investor can bu back the stocks he sold previously.
Even though the prices of the stock is going down, the investor sold the lent stocks at a higher price than the price he bought again. Thus the difference being the profit from the overall transaction. Look at the following image for a better understanding.
Risks associated with Short Selling..
Share price movements
Short Selling can only be done if the prices of the share is dropping. If by chance, the share prices increase from the point where you lent them, you'll only end up making losses. Because you have to buy them back at a higher price than what you sold them for.
Stock Shorting is done on borrowed money. That means money lent from your broker. This has significant risks as we have discussed in previous articles.
Timing is everything..
This is not particularly a risk related to Short Selling only. However the investor will have to be extra vigilant about the movement of the prices to buy them back at the lowest price possible to maximize the profits.
Short Selling is a process that could help an investor in uncertain or Bearish markets. Use the knowledge with care and you'll be able to squeeze profits out of almost all the market conditions.