Trading in the stock market is always a huge challenge due to the extremely volatile nature of stock markets across the world. The fact is that stock trading is an expert's job and only a small percentage of the world's traders actually make profits. Among the stock traders, many are not aware of the definition and techniques of selling short.
What is Short Selling and How is It Done?
In normal trading, we buy stocks of a company at their lower levels and sell them at their highs to get decent returns. However, in short selling, we sell the shares of a company which we actually do not own, at the current market price, with the aim of buying them at lower levels.
Naturally, by selling them at high prices and subsequently buying them at lower ones will help us get fantastic returns in a short period of time. However, there are some questions:
- Which stock should be short sold?
- How to identify the stocks that will go down over a period of time?
The answer to these questions is - by studying the technical charts and patterns of stocks and understanding market conditions properly. You should look for the stocks whose valuations have exceeded their fundamentals and are very expensive at current levels.
If you feel that the stocks have risen to such great levels only because of excessive buying and not because of strong fundamentals, then you can consider 'going short' in these stocks. A short seller needs to keep a close tab on the news inflow in the market.
He should conduct a detailed study of the finances of the company to predict that the stock price will go down. For example, if you can predict that the quarterly results of a certain company will be below the market expectations, you can have a short position in that stock.
This method of trading can result in heavy losses if the value of the shares goes on increasing instead of decreasing. So, having a stop-loss above your buying price is advisable to avoid huge capital losses.
Should It Be Banned?
This has been a topic of big debate in many countries. This is because some people use it as a means to hammer down stock prices in a falling, volatile and weak market. If too many short positions are initiated in a stock, then it is bound to go down.
In this case, the support levels for the stock on the downside can get breached one by one, causing heavy financial losses to those investors who have bought the stocks for long-term investment purposes. That is why, many people suggest banning it to protect the interests of small retail investors.
However, by implementing strict laws and rules, malpractices in this type of trading can be curbed. The stock exchanges in the world have taken notice of these facts and have come up with permanent solutions, thus, bringing more transparency in stock market operations.
Hope that the explained selling short will help you understand things better. Such trading can be learned only by experience and hence, traders should not get disheartened over initial failures.
DISCLAIMER: This information is just for reference purposes and does not recommend any stock market transactions.