My ideas about Short Selling and What is Short Selling a stock?
In trading, shorting stocks is referred to try to profit from falling stocks. From day one in school, you were taught all kinds of wonderful investment strategies such as buy low and sell high or buy higher and sell higher (my strategy). It sounds very unnatural to profit from falling stocks. Nevertheless, Shorting is a genius idea. If you ask me, nothing in the financial world comes close to allowing short selling. It simply is a splendid idea for speculators like you and me.
This will never happen in any places other than trading. When you buy a piece of real estate and hold onto it for a few years, you sell it for a profit if it has appreciated over the years. It is all sound and good. What if you go tell a housing developer to lend you a piece of real estate and sell it at 2017, buy it back in 2019, give him back the real estate and you keep the difference? He would think you are just out of your mind. He also must think you are one crook because you profit from his pains. So in real life, you cannot ask someone to lend you something and short selling it for a profit even if it is a technically sound idea.
However, you can enjoy shorting here in the stock market. In order to short stocks, you will have to borrow stocks from your broker. Your broker normally keeps a constant ratio between the number of shares shorted and the total number of shares in his inventory. Let’s say that number is 40%. Then it will be hard to borrow the stock to short once the number reaches that level. That is why you can not short some stocks sometimes. And you can short them again after a little while. If a broker loans you any shares to short without any inventory, it is called “naked shorting”, which is illegal.
Here are a few unique characteristics about shorting
- When a stock drops, it tends to move much faster than when it goes up. Here is why. In reality, the Bulls far outnumber the bears since people are taught that shorts are unethical and you should be investing instead of speculating, blah, blah… Therefore, when a stock goes down, there are a lot of panicked bulls that trample each other, thus causing a stock to drop very fast.
- Stocks can drop on their own weight. Have you seen stocks that drop a little bit every day without any volume for a long time? Sellers (shorts and panicked bulls) just gradually pile on each other every day. However, stocks seldom go up without any significant buying power and volume. Only cornered stocks would move without any volume.
- If you short a penny stock, it might gap up 500% tomorrow morning, which is very rare. In addition, you should be fine if you keep your positions small , However, the most you can lose on a long position is 100%, which is also very rare.
REDUCING RISK AND PROTECTING CAPITAL
Reducing risk to your money and protecting your trading capital must come before making money in the stock market; it must always be put first in your mind when trading. You must learn and become comfortable with this being your first priority when trading. I know that sounds a little strange, but it’s 100% true and a very important mindset to get into. After all, you can’t play the game if you don’t have the dollars. You should always be willing to give up a trade in order to reduce risk and save capital.
You absolutely must seek to reduce risk and protect yourself at every turn in the stock market, even before making a profit. Don’t get me wrong, you are here to make a profit, but never at the expense of taking silly risks.
Always consider the risk to reward ratio of any trade you plan to take up. What is the risk? What is the reward? Keep that ratio in your favor and you’ll be well on your way to making a good start in the trade and protecting your trading capital. I would rather miss 10 trades, then make 10 bad ones. Any trader would. Reduce risk, reduce the risk! Bad trades, mistakes, and large risks are like leaks in a dam. Forget about everything until you correct the leaks, then worry about increasing the water level.
Shorting is not for everyone. As I said many times, you do not have to know how to short stocks to be a great trader. You can be a great net long trader as long as you know when to stay out of the market when it is getting ugly.