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Short sales: what is it and how does it work?
When you are learning about Trading, it is normal to come across some concepts that, despite understanding them naturally, are more professional than you think. A clear example is Short Selling, basic but very important.
Both in cryptocurrency trading and in others such as Forex, short sales are the most basic operations that we can find in this world and below we are going to give you a quick guide.
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What is short sales?
Short selling is a strategy used in the financial market in which an investor sells an asset that he does not own, betting on the fall of its price. This practice is widely used by investors who believe that a particular asset is overvalued and wish to benefit from its devaluation.
Thus, short selling is motivated by the expectation that the price of that security will fall, regardless of the reason.
This strategy is particularly common in the stock market, but can also be applied to other financial assets such as commodities and currencies. However, it is important to emphasize that short selling involves significant risks and should be undertaken with caution.
How does short sales work?
As mentioned above, short selling is a strategy used by investors to profit from the falling value of a stock. For your better understanding, here's how it works:
- Locate the asset: the investor identifies an asset that he considers overvalued and expects its price to fall in the future. This can be a stock, a bond, a currency or any other financial instrument traded in an appropriate market.
- Borrowing the asset: the investor contacts a broker or another investor who owns the desired asset and asks to borrow it. This is done through an asset lending agreement, in which the investor who owns the asset agrees to lend it to the investor who wants to sell it short.
- Sale of the asset: after borrowing the asset, the investor immediately sells it on the open market. This sale creates a short position, where the investor now owes the asset to the original owner.
- Wait for the price to fall: the investor waits for the price of the asset to fall. If the strategy is successful and the market price of the asset actually falls, the investor can profit from the difference between the sale price and the repurchase price.
- Buying back the asset: when the investor decides to close the short position, he needs to buy back the asset on the open market. He can now buy it back at a lower price than the initial selling price.
After repurchasing the asset, the investor returns it to the original owner, closing the loan. The short position is closed and the investor can realize his profit or loss based on the difference between the sale price and the repurchase price.
What are the advantages of short sales?
Short selling, while a strategy that involves considerable risk, can offer some advantages to investors. Here are some of the potential advantages of short selling:
- Profiting from a bear market: short selling allows investors to profit from the falling value of an asset. This can be especially useful in bear markets, where most stocks tend to lose value. By using short selling, investors have the opportunity to profit even when the market is falling.
- Diversification of strategies: Short selling can be used as an additional strategy to diversify the investment portfolio. While most investors buy stocks in the hope that they will increase in value, short selling offers the opportunity to profit when prices fall. This allows for diversification of strategies, reducing reliance solely on positive market performance (e.g., owning cryptocurrencies, stocks and currencies).
- Taking advantage of bear market opportunities: in bear markets or in crisis situations, it is common for many assets to lose value. Short selling allows investors to take advantage of these market opportunities, seeking profits from falling prices. This can be particularly relevant for investors with the ability to analyze and predict market trends.
What are the risks of short selling?
Short selling presents a number of risks that investors should be aware of before implementing this strategy. Here are some of the main risks associated with short selling:
- Unlimited losses: when selling short, the risk of loss is theoretically unlimited. Although the maximum profit is limited to 100% (if the share price falls to zero), the share price can rise indefinitely. This means that losses can accumulate rapidly as the share price rises, and the investor is forced to buy back the shares at a higher price to close the short position.
- Volatility risk: Financial markets can be volatile, and stock prices can fluctuate considerably over short periods of time. Volatility can cause rapid and unpredictable movements in stock prices, increasing the risk for investors who sell short. A sharp change in share price can result in significant losses or margin calls.
- Regulatory restrictions: Some countries and jurisdictions have specific regulations regarding short selling. These may include stricter margin requirements, temporary restrictions on certain assets or even outright bans on short selling in certain circumstances. Investors should be aware of the applicable regulations in their region and comply with all relevant rules and requirements.
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Is it worth short sales?
The decision to sell short is an individual choice and its success depends on the investor's investment strategy, risk tolerance and knowledge. While short selling can offer profit opportunities in bear markets or in specific situations, it also presents significant risks that should be carefully evaluated.
Here are some tips to keep in mind when evaluating whether short selling is worthwhile for you:
- Knowledge and experience: short selling involves a solid understanding of the market and securities analysis. It is important to have knowledge of the currency, its outlook and the factors that can affect the stock price. In addition, experience in investment strategies and risk management can be helpful when short selling. Seeking out a trading academy can be a good step.
- Risk tolerance: Short selling is a high-risk investment strategy, as losses can be unlimited. It is important to assess your risk tolerance and determine if you are prepared to face the possibility of significant losses. If you are risk averse or uncomfortable with the possibility of substantial losses, short selling may not be right for you.
- Market analysis: Short selling requires careful analysis of the market and price trends. You must assess whether you have the skills and resources necessary to conduct proper analysis and identify short selling opportunities. The ability to correctly predict falling stock prices is critical to success in this strategy.
- Regulations and restrictions: It is important to check your region's specific regulations and restrictions regarding short selling. Some countries may have stricter margin requirements, temporary restrictions or outright bans on short selling at certain times. Make sure you understand and comply with all applicable rules and regulations before implementing this strategy.
Short selling with TruBit
Short selling in trading allows you to profit from downward movements in a wide variety of assets, such as currencies, commodities, stocks, bonds and cryptocurrencies. To successfully trade these types of orders, it is essential to choose the best time to place them. In addition, it is essential to use a broker that offers well-established technical analysis tools on recognized platforms.
One internationally recognized and regulated broker that offers these features is TruBit. TruBit allows you to trade different instruments on their platforms, which are suitable for both experienced traders and beginners. Their platforms offer advanced technical analysis tools, which can help you identify short-selling opportunities and make informed decisions.
Conclusion
In this trading method, it is common to "borrow" shares from an exchange or broker and then sell them on the market, waiting for a fall in prices to buy them back and return them to the broker. To sell short successfully, it is important to follow market movements closely and have a bearish view of the asset you want to sell.
Investors may choose to sell short if they perceive a downtrend in the market or a major news event that may affect the price of the asset. However, it is essential to remember to set stop-loss levels to limit potential losses in case the market moves contrary to your expectations.
