How to sell a stock short

Short selling is an advanced investment or trading strategy that speculates on a decline in a stock or other kind of securities. For traders, short selling is a kind of speculation, while for investors short selling is a kind of hedge against the downside risk of a long position in the same security or in a related one. 

Speculation is an advanced trading method that involves the possibilities of substantial risk while hedge is a more common kind of transaction that involves placing an offsetting position to reduce the risk exposure level of investment. 

In simple terms, an investor or trader short sell by borrowing the share of an asset with the belief that the asset would decrease in value in future time. The investor then sells the borrowed stock at its actual market price with the belief that once the market value of the stock decreases, he or she would be able to get it at a reduced value. The investor who is short selling believes that he or she would be able to get the asset or stock at reduced market value before its maturity date.

Short sell is risky because instead of decreasing in value, the stock or asset market value can climb. 

How To Short Sell For Profit

Assuming an investor who believes that an ABC stock will reduce in value in the next six months. He or she then decides to borrow 100 shares that are currently trading at $60. The investor then sells off the borrowed stock for the current market value of $60. However, after two months the stock market value suffers a decline as predicted by the investor and begins to sell for $40. The investor who borrowed the stock bought the 100 stock back for $40 each to replace the borrowed ones. In this instance, the investor gained some profits because his or her prediction happened as expected. The investor or traders profit on the short sale excluding commission and interest is $2,000 ($60 - $40 =$20 x 100stocks = $2,000).

Short Selling For A Loss

Using the above scenario, let’s now assume the trader refuses to close out when the stock value reduces to $40 with the belief that the stock value will still reduce and he or she would be able to make more gain. But instead of making more gains, the stock price skyrocketed after three months to $75. The reason for this increase might be because a competitor swoops in to acquire the company with a take over offer of $75 per share. This is inadvertently a loss for the investor should he or she decide to close out. The loss on stock would be $1,500 ($60 - $75 = $15 x 100 = $1,500 loss).

Short Selling As A Hedge

Another advantage of short selling is a hedge. The major aim of short selling as a hedge is for protection. Hedging is undertaken to mitigate loss or protect gains. However, unlike speculation, hedging comes with a significant cost. This is why many investors do not consider hedging. For instance, if 50% of a portfolio that has a close correlation with the S&P 500 index is hedged and the index moves up to 15% over the next 12 months, the portfolio would only record approximately half of that gain or 7.5%

Pros And Cons Of Short Selling

Short selling can be a loss if the initial guess of the trader did not turn as expected. A trader who has bought stock cannot lose more than 100% of their outlay if the stock moves to zero. However, in the case of shorted stocks, he or she can lose more than 100% of the investment. The advantage and disadvantages of short selling include:

Pros

• requires little initial capital
  
• possibility of high profits
  
• hedge against other holdings
  
• possible leveraged investments
  

Cons

• necessary margin account
  
• possibility of high losses
  
• incurred margin interest
  
• short squeezes
  

Finally, it is advisable that if you are a beginner investor avoid short selling. Short selling is often done by an advanced investor or trader who has mastered market volatility and market sentiment. The safest kind of short selling aside from short selling through hedge is short selling through ETFs. This is because of the lower risk of a short squeeze.