Aside from the basic buy-and-hold strategy, there are other ways of earning money from the stock market. One of them is short selling.
What is short selling?
Selling short, or going short, is a technique that investors can use to try to gain something out of a declining stock or currency value. Basically, this one goes to the opposite direction of the overall market, which hopes that all stocks will rise in value for them to gain some profits.
Short sellers make money on the losing side.
How does it exactly work?
Let’s suppose that you want to short sell around 100 shares of a company that you think will lose some figures due to their earnings’ weakness. Your broker will borrow some of those shares from another entity that has them. The shares should, of course, we returned later.
You will then sell the borrowed shares at the current market price, particularly before it slips down. Your main goal is to buy the shares back once your awaited decline finally takes place. When you buy it, you are “covering your position.”
Once you’ve covered your position, you will get some profit from the difference of the price at which you sold the borrowed shares and the price at which you bought it back for a lower price.
Which Traders Go Short?
There are many investors who prefer short selling more than other strategies. Some investors may not be good at spotting underpriced but good stocks. Rather, they’re better off with hunting for overpriced bad companies.
Another reason why investors grab at the opportunity to short sell a losing stock is because many institutions do not engage in any kind of short selling. This means that you got a lot of short selling opportunities at hand with less competitors.
Lastly, investors think that having both long positions and short positions makes their portfolio of investments less volatile.
Which companies can be short sold?
If you’re planning to become a short seller, you might want to target companies with the following characteristics:
- Small cap companies that momentum investors have ridden on. These companies are also typically the ones most difficult to value.
- Companies that sport much higher price to earnings ratios than their growth rates can justify.
- Companies that are awaiting tougher and larger competitions.
- Companies that you deem have useless or bad products or services.
- Companies that you think only have temporary fame, or companies that just go with the flow of new trends and fads.
- Companies that lean too much on a single product or service.
- Companies that sport weak financial health and statements, like bad balance sheets, negative cash flows, and other similar documents.
This doesn’t only apply for stocks. It’s also very rampantly done in the currenc markets. In fact, short selling is sometimes frowned upon by market participants, since an investor practically wishes the company bad luck whenever he goes short on its stock.
Nevertheless, short selling can be a very profitable venture if done properly and carefully.