What Exactly Is Short Selling?

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In the dynamic world of the investments, you will encounter the term “short selling”. How does it work and what are the rules behind it?

The age-old practice in investing is that you will profit by purchasing stocks in a low price and selling them for a higher price. Although you have invested in a seemingly good performing economy, some stocks or securities may go down. You cannot earn money by “buying low and selling high” in this circumstance. Fortunately for you, there is another way to make money! That is short selling.

Short selling plays a soothing music to the risk-taker’s ears. Its concept is relatively simple. It takes advantage of the market transitions from higher to lower prices. It occurs when an individual borrows a stock, sells it for a higher price, and purchases the stock again at a cheaper price. Watch this short video to grasp its essence:

Most local brokerage firms let you experience the ease of selling short. Just place an order to sell the stock and communicate with the broker. The brokerage firm will borrow the shares for you to sell. Then, it loans the shares to your account and conducts the sell order.

As with everything, rules shall apply. Here are just some of the common rules in short selling:

1. The “Uptick Rule” is one of the key edicts that short sellers abide. It refers to selling a stock short only when the last trade was a move up. You cannot short a stock that is moving down.

2. The odds may not be in your favor if you heard that a flock of investors are shorting the same stocks that you are shorting. There are so many risks if you short a stock that everyone else does. They can simply abandon their shorts if things do not go as planned. Doing so will drive the price to hike.

3. Short selling during seasonal holidays or during “options expiration week” may attract painful losses because those circumstances do not follow the natural or normal supply and demand.

Short selling takes advantage of the market transitions from higher to lower prices. The steep learning curve intimidates some investors, leading to avoiding it entirely. It is undoubtedly a skill that experienced investors develop!

Sources: 1, 2, & 3

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