A Complete Guide to Short Selling

What short selling is and everything else

The topics that we will cover in this article are: How can each of us play our part in an exchange rate decrease; What is short selling as a general concept; What are the rules of short selling; As well as how possible it would be to shorten the market.

Surely you have heard the phrase that speculators shortened or, in other words, briefly sold a currency, a stock, and specifically mortgage-backed securities – like those shown in The Big Short. A 2016 film that highlighted the dark pits of the modern financial world was led by Director Adam Mckay.

It is likely that this negative-sounding news is causing short deals to be embedded in the back of people’s minds.  At first glance, it may not be clear, and even a little alien, but it is possible to profit from a depreciation.  In what follows, we show that without shorting, not only would the cinema world be poorer by one great film, but that shorting is one of the defining gears of the entire capital market machinery.

If we interviewed people about the nature of the profits made in trading, the vast majority would buy cheaply to then sell more expensively and enjoy the profit generated by the exchange rate inflation. 

There is also a gap in this, because in the long term, when at this with a perspective of 20 or 30 year, stock prices will generally tend to creep upwards on the chart.    

But what if we think the price of a product is skyrocketing or massively overpriced and will soon fall?

You don’t have to be a stock market magnate to realize that rising and falling exchange rates are constantly following each other. If the market rises, the rising waves are longer, and in the case of bear markets, it is the other way around. It makes sense to enjoy the downward wave in order to reach cheaper buying prices.

Riding this downward curve is, in essence, what short selling is there to help you to do.

A short position (or short trade/short selling) means speculating on a fall in the price, i.e. generating a profit when the price of the selected product decreases. In the case of short selling, therefore, we start trading with a sale, and the plan is to close it by buying at a lower price in the future.

HOW IS THAT POSSIBLE?

If you open a short position, the brokerage company will lend you the product you want to shorten.  This allows us to sell what we don’t have. Yes, but the borrowed product has to be returned over time, that is, as opposed to a buying position, where you can hold these shares and give them to your grandchildren, you can typically open the selling positions for a shorter term, up to a maximum of a few months. 

WHEN WILL THE SHORT POSITION BE PROFITABLE?

A short position started with a sale will be profitable if the price of the instrument decreases, in other words, if I sell and buy it cheaper.

Keep in mind that while your risk for a long position is capped, at worst the company will fail and the exchange rate will be 0. On the other hand, there is virtually unlimited vertical space,  and there is no ceiling to hold back the exchange rate price. For example, the price of Tesla, depreciated by $100 at one point and then was above $1,000 a few months later, which in this case would result in a loss of $900 per share. In the case of short selling, it is therefore essential to focus on the appropriate risk management.

WHAT IS A FUTURES INDEX?

The development of futures trading in the mid-1800s was driven by the need for the producer and the user to be able to sell or buy at pre-fixed prices. In the case of a miller, it is useful to know in advance as early as February how much wheat will cost in July, while it is also an advantage for the producer to know how much revenue he can expect even at the moment of sowing. In this situation, the producer sells, the miller buys the July wheat futures contracts. Actual physical delivery is increasingly rare on the futures market, with the buyer and seller mostly accounting for the difference in exchange rate movements in money.

Futures are concluded by some market participants for so-called hedging and risk reduction purposes. For example, a European export company sells its expected dollar revenue against the euro on time, thus securing the exchange rate for itself in advance.  In the case of futures stock market indices, an investment fund manager may reduce the risk of position by selling stock market index futures without selling existing shares if it fears a market fall.

Similarly, for any regulated market that is traded by any man, speculators give the most of the trading on the Futures Exchange.

The majority of futures market participants therefore simply want to benefit from the exchange rate shift, taking advantage of the fact that futures products can be traded up and down without any restrictions.

Trading a futures product is like anything else, if you expect a rate hike, buy it, if you sell it for a drop, you sell it.  There are four differences from the stock market:

Futures products have an expiration date, upon which the product expires and ceases to exist. There are usually quarterly maturities, so there’s always something new to continue doing business with. The fact that the futures product has an expiration date does not mean that it is not possible to close the position at any time before that date nor is it impossible to open a new one at any time. In the case of futures products, the easiest way is to ride the exchange rate decrease is to open a short position.

For futures products, a unit price shift usually causes a higher profit or loss than for a share. For example, in the case of the E-mini S&P 500, a 1 point shift causes a profit or loss of 50 USD. Futures allow for leveraged trading, i.e. we can take positions that exceed our personal equity. For a disciplined trader who knows the rules of position sizing, leverage is irrelevant. Leveraged trading can easily become Russian roulette, only all six bullets are already in the gun. In the case of futures products, the basic unit of trading is called a contract, so you trade one or more contracts with the Stock Exchange.

Let’s say a few words about short selling on the stock exchange.

Short selling on stock exchanges is not much different from buying positions.

Finally, let’s have a couple of cutting-up terms techniques that will make us the stars of every party next to the nodding pots.

WHAT IS THE DIFFERENCE BETWEEN SHORT SQUEEZE AND SHORT COVERING?

The short squeeze has accelerated the buying surge among short-buyers as a result of a rise in the price of a security. The rise in the stock price is prompting short-time buyers to buy back their short positions and book their losses. This market activity causes a further increase in the price of the security, forcing more short-backs to cover their short positions.

Unlike short squeeze, short-covering means the purchase of securities to cover an open short position. In order to close the short position, traders and investors buy the same amount of shares from the securities they shorten.

Let us give you an example:

Zane will be the name of our character.

If Zane shorts 500 ABC shares at $30 per share, and then the ABC stock price dropped to $10. And if He then covers his short position by buying back 500 ABC shares at $10 per unit. This would earn him $10,000 worth of profit; (($30-$10)*500).

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