If you never learned how to make money when the stock market is taking a dive than this article is for you. Here we'll explain the basics of short selling in simple words for you to grasp the concept. We all know that to make money with stocks one needs to buy low and sell high to pocket in the difference, but what about the opposite? what if the market is crashing? If we're confident that the market will go lower, we can sell shares now and buy them back later when their market value is lower.
How can I sell shares I don’t own?
When you open a short position, those securities are borrowed from a third party, usually your broker and then sold in the market. The loan occurs automatically upon opening the short position. The idea is that later in time you'll buy back those shares from the market and return them to your broker. Now, if the market went lower and you bought the shares at a lower price than that of what you sold them, your broker will let you pocket the difference. However, if you were wrong and the stock market went higher, you'll lose money, as now you sold shares at a cheaper price than the current market value.
1) Profit from a falling market: If you are confident that a stock is defiantly overpriced now, you can short it and wait for the market to correct itself.
2) Hedging: Hedging is concept to reduce risk, if you have too many long positions, you can find an overpriced stock and short it in order to "hedge" your portfolio
1) UNLIMITED Risk: the main disadvantage of short selling is unlike long positions that has limited risk, short positions actually has unlimited risk. Long positions have a cap loss when the stock reached 0$, but for example, if you short a stock at 10$, there is no cap to what future price it can reach. Short selling can wipe your account and than some.