By Brigitte Yuille
Short selling is another technique you can add to your trading toolbox. That is, if it fits with your risk tolerance and investing style. Short selling provides a sizable opportunity with a hefty dose of risk. We hope this tutorial has enabled you to understand whether it's something you would like to pursue. Let's recap:
- In a short sale, an investor borrows shares, sells them and must eventually return the same shares (cover). Profit (or loss) is made on the difference between the price at which the shares are borrowed compared to when they are returned.
- An investor makes money only when a shorted security falls in value.
- Short selling is done on margin, and so is subject to the rules of margin trading.
- The shorter must pay the lender any dividends or rights declared during the course of the loan.
- The two reasons for shorting are to speculate and to hedge.
- There are restrictions as to what stocks can be shorted and when a short can be carried out (uptick rule).
- Short interest tells us the number of shares that have already been sold short in a security.
- Short selling is very risky. You can lose more money than you invest but are limited to 100% profit on the upside.
- A short squeeze is when a large number of short sellers try to cover their positions at the same time, driving up the price of a stock.
- Even though a company is overvalued, it may take a long time for it to come back down. Fighting the trend almost always leads to trouble.
- Critics of short selling see it as unethical and bad for the market.
- Short selling contributes to the market by providing liquidity, efficiency and acting as a voice of reason in bull markets.
- Some unethical traders spread false information in an attempt to drive the price of a stock down and make a profit by selling short.
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