What is Short Selling?
Two basic components make up trading, long and short.
To ‘go long’ or ‘take a long position’, is a traditional strategy for most individuals involved in the market in which a trader aims to make a profit by buying low and selling high.
For example, a trader may purchase at $5 a share, hold for a period of time, and then sell at $7.50 a share, booking a 50pc profit in the process.
This strategy is all good during a bull market, or if you possess an insight, or edge.
However, during a down market, or in light of poor future stock prospects, one cannot necessarily buy low sell high.
In this instance, short selling can be used to book a profit, which is where a trader profits by the fall in a share price.
This occurs in a number of steps:
1) Find stock with poor prospects with a likelihood of a fall in the share price.
2) Borrow said stock from broker e.g. 10 shares
3) Pay interest to broker for borrowed stock
4) Sell stock on the market: 10 shares at $5 p/s = +$50 from sale.
5) Once expected fall in price occurs, purchase stocks back: 10 shares at $4 p/s = -$40 for purchase.
6) Return borrowed stock to broker and in the process book a profit of $10 ($50-$40).
Short selling is a risky strategy as there a limit on the possible profit however there is potentially limitless loss as the price rises.