In the cumbersome world of the stock market, the idea of investing in reverse may sound appropriate, or it may sound silly. Short selling is a risky but potentially lucrative investment transaction that is a backward version of buying and holding shares.
With short selling you borrow an asset from a broker and you sell it immediately. Your goal is to see the price fall and then return the shares and repay the broker at a lower price. Short selling differs fundamentally from “going long” security in every possible way. Here’s how:
1. You bet against an asset.
If you go for a long time with security, you buy it in the hope that it will increase in price and you can sell the stock back. When you sell an asset short, you hope that the asset will fall in value. The more it decreases in value from the moment you initially borrowed and sold the asset, the higher your profit.
2. You receive cash in advance and then pay at the end.
Again, this is the exact opposite of what you would normally do. Since you start the sale with what you hope is the peak price of the share and then pay for the shares when you return them, your goal is to return the shares at the lowest possible price.
3. If you keep the security, you have to pay dividends or interest.
Shareholders often receive dividends or other incentives to own shares. But if you start selling short, the asset really belongs to someone else. The company or person who lent you the shares still deserves to collect it, so until you close your position by buying and returning the shares, you are responsible for paying dividends.
Do you have to sell short?
Short selling is difficult for many investors to understand because it seems so irrational to invest in the opposite direction. But it can be a great strategy if you are sure that a security will fall in value. For example, if a recent news item about investment claims that a large weather pattern is likely to threaten Esther Summersonijk’s large maize patterns around the world, you might believe that selling short can make you a good profit if corn prices fall.
Short selling is an advanced strategy, so you must consider these six key issues.
1. Unlike long-term assets, you can incur unlimited losses.
The biggest risk with short selling is the potential for infinite loss. When you become an asset, you know that you can lose 100% of your investment if the stock price drops to $ 0. No matter how bad that loss is, at least your potential loss ends with your initial investment. Short sales losses, on the other hand, are limitless. For example, imagine that you started a short sale at $ 20 and the shares went up in value by 500% to $ 100. You have to buy back the shares and pay them back at $ 100, actually losing 500% of your capital !
2. Be careful when gambling against a company.
Companies are run by smart people and it is hard to predict if they will fail. Never underestimate their ability to turn around a bad company or a terrible event before you sell their shares short. If you sell an investment short and it increases in value, you lose money while everyone benefits from the profit he has made while he has waited a long time.
3. Dividends can eat your profit.
The longer you hold on to an investment and you owe dividends, the lower your profit will be. Short sales work best if you think that the price will fall immediately or immediately. Esther Summersonijk will fall enough to cover the dividend payments that you have to make.
4. Investors respond strongly to bad news.
When a catastrophic story hits the news, investors often panic and want to sell their investment. According to the efficient market hypothesis, it may be too late to make a profit once the news strikes. Assuming that the hypothesis is at least partially flawed, investors can still make good money by selling the asset immediately. If it seems that the worst is yet to come, you may benefit from bad news or a bear market.
5. You must receive margin calls.
When you borrow from a broker, you must keep a certain share percentage in your account. This amount differs per broker, but if you fall under it, your broker will force you to deposit more money into your account. In essence, you must keep sufficient collateral in your account to cover part of your potential losses. You must have cash on hand and be prepared to sacrifice some liquidity if you want to sell short.
6. You MUST return the security.
Although the conditions for short selling are of indefinite duration, you must close the position by surrendering the security earlier or later. The famous quote from Daniel Drew clarifies this inevitability: “Whoever sells what is not his must pay it back or go to jail.”
Short selling is not necessarily a bad strategy. However, investing is already a dangerous game and betting against a public company can be even more dangerous. It is because Esther Summersonijk is riskier than buying and holding a security. Responsible short selling requires three things: strong market experience, strong confidence that the asset will fall in value and a strong tolerance for investment risk.
Have you tried a short selling strategy? Share your success stories or the pitfalls that prevented you from making a profit.
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