Shorting stocks has always been a popular trading technique. Shorting stocks is also commonly known as short selling. It involves the sale of stocks that the seller does not own. The seller usually takes a loan of shares from a broker.
What is short selling?
Short selling is when a trade initiated by sells borrowed stocks and buy it back later at some point in the future.
Why short selling?
Stock sellers usually take this transaction since they know that the stock price will go down. Thus, if they sell today, then they will have the chance to buy it back at a lower price at some point in the future.
They make a profit only if they accomplish that process. Their profit depends on the difference between their sell and buys prices.
Some people do short selling purely for speculation, while others do it to protect their downside risk. For instance, they know that the price of their stocks has started and will continue to drop. Therefore, they sell it now, in order to avoid bigger losses.
Also read: Stock Trading 101: Why are Market Makers Essential?
What are the risks?
In shorting a stock, you get exposed to a potentially large financial risk. If you want to sell a stock short, do not assume you will always be able to repurchase it at the time and price that you have planned before.
The market for a given stock has to be there. If no one is selling the stock, or there are many buyers, including panic buyers, caused by other short sellers attempting to close out their positions as they lose more and more money, you may be in a position to incur serious losses.
Or else, there is a possibility that the company gets acquired for a 40 percent premium over its current stock price including a special $10 per share dividend. That means short-sellers are instantly impacted and may have serious losses.
