What Is Short Selling And How You Can Profit From It
Most people know how money can be made in the stock market. You buy it low and then sell it higher. The difference is the profit which you get to keep. That is why most people can make money when the stock market rises. But not everyone know that it is possible to make money when the stock market drops.
The way to make money when a stock drops is to do some short selling.
Short selling takes advantage of the fact that every market and stock will go through 4 stages. Learn about the 4 stages by reading The 4 Stages Every Stock And Market Goes Through
Short selling is when you sell a stock first and then buy it back later at a lower price. For example, the current price of a stock may be $45. So you sell short the stock at $45 and when the stock drops to $40, you buy it back. The difference of $5 is your profit. If you find it hard to understand, imagine that you are a car dealer.
A car dealer does not own the car that a customer wants. You may own a car showroom with samples of the car but ultimately it is the customer who will choose which model and which color they want to buy. You do not have the car in your showroom but you notify the car manufacturer that your customer wants which model and which color. Although you do not have the car your customer wants you still sign the contract with him and sell him the car for $45,000. You are in fact selling him or her something you do not own.
Later, when the manufacturer supplies you the car, you pay the car manufacturer the $40,000. The difference of $5000 is your profit. That is an example of short selling.
The way to make money when a stock drops is to do some short selling.
Short selling takes advantage of the fact that every market and stock will go through 4 stages. Learn about the 4 stages by reading The 4 Stages Every Stock And Market Goes Through
Short selling is when you sell a stock first and then buy it back later at a lower price. For example, the current price of a stock may be $45. So you sell short the stock at $45 and when the stock drops to $40, you buy it back. The difference of $5 is your profit. If you find it hard to understand, imagine that you are a car dealer.
A car dealer does not own the car that a customer wants. You may own a car showroom with samples of the car but ultimately it is the customer who will choose which model and which color they want to buy. You do not have the car in your showroom but you notify the car manufacturer that your customer wants which model and which color. Although you do not have the car your customer wants you still sign the contract with him and sell him the car for $45,000. You are in fact selling him or her something you do not own.
Later, when the manufacturer supplies you the car, you pay the car manufacturer the $40,000. The difference of $5000 is your profit. That is an example of short selling.
- When you long a stock, you buy a stock and profit when you sell the stock at a higher price
- When you short a stock, you sell a stock and profit when you buy back the stock at a lower price
The traditional way to make money in the stock market is shown in the chart above. You buy AMZN at a lower price and then sell it higher to make a profit.
Sophisticated traders take advantage of the rise and fall of stocks and make money in uptrends and downtrends. In the chart above, you can see how a trader can profit from the fall in VRX. A short seller will sell the stock at a higher price and then buy back (cover the short) at a lower price. The difference is the profit that he or she will make.
The many ways to short a stock
The way to short a stock is to learn some short selling trading strategies. I will be writing about these trading strategies later when I have more time so do come back often to learn about these strategies.
In the chart above you can see how NCLH experienced a downtrend. NCLH gave many trading opportunities to short seller at different times. The 200 day moving average can sometimes act as a resistance and give the trader a shorting opportunity. To learn more about the 200 day moving average, read How To Use The 200 Day Moving Average To Trade Stocks.
Short selling is just as risky as buying a stock. When you buy a stock there is a risk that it can drop. When you short a stock there is a risk that it may rise. The difference between them in theory is that a stock can only drop to zero but a stock can rise to unimaginable levels and thereby a short seller has unlimited risk. The usage of protective stop losses will help limit your losses.
There are some events which may give the short seller a massive loss. They are when earnings for the stock is announced and if a sudden news of takeover or buyout of the company happens. A stock may gap up dramatically when such news appears and that can give the short seller a big loss without being able to get out when the gap goes above your stop loss overnight.
Therefore, it is important for a short seller to constantly be aware of earnings date for their stock and any news that may hint of a merger or acquisition.
Short selling is just as risky as buying a stock. When you buy a stock there is a risk that it can drop. When you short a stock there is a risk that it may rise. The difference between them in theory is that a stock can only drop to zero but a stock can rise to unimaginable levels and thereby a short seller has unlimited risk. The usage of protective stop losses will help limit your losses.
There are some events which may give the short seller a massive loss. They are when earnings for the stock is announced and if a sudden news of takeover or buyout of the company happens. A stock may gap up dramatically when such news appears and that can give the short seller a big loss without being able to get out when the gap goes above your stop loss overnight.
Therefore, it is important for a short seller to constantly be aware of earnings date for their stock and any news that may hint of a merger or acquisition.