In the stock market, in addition to buying stocks to make money on the upside, investors can also make money on the downside of the market through a strategy known as “shorting”. Shorting is a speculative tactic that involves selling stocks short for a profit. In this article, we’ll take a closer look at what it means to short a stock and how investors can use this strategy to find opportunities in a volatile market.
What is shorting?
Shorting is an investment strategy whereby an investor returns the borrowed assets and makes a profit by borrowing those assets and selling them immediately without owning the underlying assets, and then buying them when the price falls. In short, shorting is an investment behavior to gain profit by predicting the fall of an asset’s price.
Borrowing stock: The investor borrows a certain amount of stock from a brokerage firm, usually through securities financing.
Short selling: The investor sells the borrowed stock immediately and gets the money to sell the stock.
Waiting for a Decline: An investor hopes that the price of a stock will fall so that he can buy the same number of shares at a lower price in the future.
BUY BACK: When the price of a stock falls, the investor buys the same number of shares with the funds received and then returns those shares to the broker.
Profit: If the price of the stock falls enough, the investor will make a profit after returning the shares.
Application Scenarios of Shorting
- Expectation of market decline
One of the most common scenarios for shorting is when an investor is pessimistic about the future movement of the market or a particular stock. When an investor expects the market or an individual stock to fall, they choose to go short in order to make a profit.
- Hedging Risk
Shorting can also be used as a means of hedging a portfolio. When an investor holds a large number of stocks and wants to hedge against the risk of a market downturn, they may choose to offset the overall risk of their portfolio by shorting stocks.
- Arbitrage opportunities
In a market where there are sometimes price differences between different securities, an investor may be able to obtain an arbitrage opportunity by shorting a highly valued security and buying a lowly valued security.
Risks and challenges of shorting
- Unlimited risk
Shorting is more risky than buying a stock because the price of a stock can theoretically rise indefinitely. If an investor shorts a stock and the price of that stock keeps going up, the investor may face unlimited losses.
- Market risk
Uncertainty in the market is a major challenge to shorting. Even if an investor is pessimistic about an asset, changes in the market are influenced by numerous factors and cannot be easily predicted accurately.
- Risk of forced liquidation
If the price of a stock shorted by an investor rises, the brokerage firm may issue a request for forced liquidation, requiring the investor to quickly return the borrowed shares. This may lead to forced liquidation of the investor’s position at an undesirable time, increasing losses.
How to do shorting well?
- Adequate research and analysis
Before shorting, investors need to conduct sufficient research and analysis to understand the market and individual stock’s fundamentals, technical aspects as well as various factors that may affect the stock price.
- Setting Stop Loss Points
Since short selling has unlimited loss potential, investors need to set clear stop-loss points. When the stock price rises to a certain level, stop loss in time to control the loss.
- Use leverage carefully
When shorting, some investors may choose to use leverage to increase the size of their investment. However, leverage also increases the risk of loss, so it needs to be used with caution.
- Adjust your strategy in a timely manner
Market sentiment and the economic environment are constantly changing, investors need to keep an eye on market trends and adjust their shorting strategies in a timely manner to avoid falling into a fixed view.
Shorting and Moral Hazard
Although shorting is a legitimate strategy in the market, it sometimes raises some ethical controversies. Some argue that shorting may exacerbate market declines and negatively affect the normal economic order. Therefore, when using the shorting strategy, investors need to carefully weigh the risks and avoid abusing this tactic.
Shorting is a challenging investment strategy in the stock market that requires investors to have deep market knowledge and keen analytical skills. When utilizing shorting, investors should always be cautious and set clear risk control measures to avoid possible losses. Despite the risks and challenges associated with shorting, for investors, understanding and skillfully utilizing this strategy can help to identify more investment opportunities amidst market volatility and improve the overall resilience of their portfolios. Balancing shorting and longing strategies with the flexibility to respond to changes in the market is one of the keys to investor success in the journey of investing.