short selling

Making Money in Bear Markets – photo by poplinre

Most people don’t short stocks, people often believe that it unfair or even dishonest. Buying stocks with the hope for a profit is an entirely different matter.  Most people look to sell their stocks for a profit if the stock or the markets decline.

Shorting a stock is merely selling stock with expectation of delivering it at some future time. Shorting or going short a stock is the practice of selling  a stock that is not currently owned, with the intention of subsequently repurchasing them (“covering”) at a lower price. In the event of an interim price decline, the short seller will profit, since the cost of repurchase will be less than the proceeds received upon the initial (short) sale. Conversely, the short seller will incur a loss in the event that the price of a shorted instrument should rise prior to repurchase. The potential loss on a short sale is theoretically unlimited in the event of an unlimited rise in the price of the instrument.

“Bears can only make money if bulls push up stocks to where they are overpriced and unsound… Bulls always have been more popular that bears… because optimism is so strong.. Still, over-optimism is capable of doing more damage than pessimism since caution tends to be thrown aside… to enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without free press. There would be no one to criticize and restrain the false optimism that always leads to disaster. (Staley 1997).”

Some people fear that the person who sells first and buys later is injuring the market. They never give credit to the fact that when a person is short he/she is a potential buyer and by doing so he/she provides an element of support for the markets.

What about the element of risk. There is no more risk being short than being long. In fact the person who is short is looking to cover once anything appears to go against him. Those that are long and the stock is fully paid for the inclination is to hold onto the stock for a long period of time.

There are ways of limiting risk immediately after making a trade, one way would be to enter a buy stop order. Investors generally use a buy stop order to limit a loss or to protect a profit on a stock that they have sold short.

buy stop order

 

 

 

 

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