March 18, 2020, 2:39 pm

What is Short Selling in Trading

by: The Financial Blogger    Category: Trading
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The world of stock markets, indexes, and trading is a complex one and learning about all the different terms and language used in the business of stock trading can take a while. What are bears and bulls and why do we have initial public offerings or talk about haircuts? The list of terms is a long one but one of the most talked about terms in the media and news is short selling – but what is it?

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What is Short Selling?

To put it as simply as possible, short selling is the prediction or speculation that a certain stock will go down in value and leveraging off that prediction to make some profit. By borrowing stock and selling it at the current value, hoping that it will decrease in price, so when you buy it you buy it for the lower price is short selling stock. If your prediction is correct, you’ll sell the stock for more than you have to pay for it, and the difference becomes your profit. You’ll need a CFD trading account to start short selling.

The Difference Between Short and Long Trades

The long trade is a more traditional way of creating profit in the stock market. This is when you buy stocks when you believe the value of those stocks will increase over time. It’s a long trade because you are waiting for the value of the stock to increase before you sell them. Essentially, a long trade and buying stock are interchangeable terms, because they mean much the same thing. In many ways it’s less risky than short selling, but there is still inherent risk because the price of the stock you are ‘going long’ on can decrease too.

The Risks of Short Selling

Short selling is, at its core, quite a risky way of trading. Because you are trading with ‘borrowed stocks’, you are trading with borrowed money. Usually you’ll need to provide a collateral with your broker for the practice, and that likely involves using your owned stocks as this collateral. If you predict the fall of the price of the stocks you are shorting incorrectly, you could end up losing capital. It gets more complex from here too, because you need to meet the minimum maintenance requirements and if your account isn’t able to maintain it, you might need to put in more cash or liquidate your position – a process called a margin call.

You might also experience something called a short squeeze, where a stock might rise and those short selling the stock create cover for their trades by buying their short positions back. In essence, you’ll start experiencing something of a feedback loop.

The process of shorting selling in trading is a more advanced method of stock trading and an inherent and clear understanding of trading is needed to be successful at it. Understanding what the ideal conditions are for short selling and how you know when these conditions are met or can be expected involves a good knowledge of how to trade and predict trends on the stock market.

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