Short selling is the strategy designed to make a profit through a stock losing its value. It is the concept of selling borrowed stocks with the anticipation of a decrease in their price and buying back the stock at a decreased price. A day trader sells stocks without owning them but promises to deliver them soon.
For short selling, your brokerage firm lends stocks to you that you want to sell short from its inventory or another stockbroker. You need to buy back the same stock in the same number to close the short and return them to your stockbroker. Whether the stock price favors you or opposes you, you have to buy back the stock.
There will be two scenarios for this technique of day trading online:
- If the stock price goes down, you will get profit by buying back the stock at a decreased price.
- If the stock price increases, you will lose more money than its price because you have to pay interest to your broker.
Thus, short selling is one way to seek profits in stock market but at a high risk of losing money more than the invested amount. Several techniques can be answered on the question of how to do intraday trading to make profits. Short selling is one of them.
Short selling involves a margin as a security against your borrowed stocks. Therefore, you require a margin trading account. While opening online demat and trading accounts, you can ask for short-selling margin requirements like margin calls and the minimum amount to maintain.
Motivation to go with short selling
1. Leveraging
With short selling, traders take advantage of leveraged trading. They can generate a profit by putting up only a percentage of the total value of the trade.
2. Making a high profit
Short selling offers a high-yield reward. It is exceptionally profitable if the trader predicts the price movement correctly. Also, it magnifies profits as one can make money when stock price increases and when stock price decreases.
3. Hedging
Apart from speculation, the purpose of going short is to hedge. Investors protect their long positions by offsetting short positions and provide additional protection to the overall investment portfolio. Thus, it will be an inexpensive hedge to safeguard long positions that one holds.
Restrictions to go short
1. Potentially Unlimited Risk
Short selling carries a higher risk. A short seller can lose much more than the original investment. The greed of leveraging can result in much more than less than 100% investment. Investors without trading experience generally avoid short-selling techniques.
2. Higher trading costs
Short selling carries higher trading costs than regular stock trading that is an issue for retail investors. Interest on the borrowed money is also an expense for the trader that will decrease your funds in profitable short selling.
3. Possibility of shortage of stocks
A short-seller may get in trouble to buy the same number of shares when it comes to closing a position if a higher number of traders are also shorting the same stock. This will create havoc that can go towards a margin call.
4. Margin Amount
A trader has to maintain a minimum amount of margin in his/her margin account. If you cannot maintain this, your stockbroker with a margin call can force you to liquidate your position. If you do not want to liquidate the position, put cash in the account to overcome the liquidation.
5. Regulatory Risks
In the opinion of many regulators, short selling is not ethical because it can encourage one-way trading. Therefore, there is the risk of losing your money due to sudden possible bans to avoid unwarranted selling pressure but in a few specific sectors.
Casual investors may not be fully aware of the stock market or they may be aware but not be keen to take the route of the stock market to invest. The ones who are not fully aware of the stock market will need the advice of financial advisors to make investments. For them, the full-service broker can be suitable since they provide research and recommendations.
Thus, short selling carries a high risk/reward ratio. No doubt it can offer high profits, but losses can go infinite due to margin calls or shortage of shares.
