If there is one brahmastra in the trader’s arsenal, it is his ability to go short. Taking that analogy further, a stance to only go long and not short would be like going to war leaving half your weapons home. Certainly not something that is advisable, unless of course you are looking to be a martyr.
You must agree with the adage that the trend is your friend. If you suffer from an allergy to going short, then you must be specialist at wringing your hands in dismay. What else can you do when the market swings downwards, as it so often does?
You all must be aware of the current corrections in markets. This is something not to be worried about because all the markets across the globe go through correction. A trader should see this as a long term buying opportunity and why not we always like to buy things when they are available at a cheaper price that is why we always get excited whenever we see the word “SALE”. So why not in the financial markets.
The two primary reasons for selling short are opportunism and portfolio protection. Occasionally we see a stock that we believe has gone up too high too fast. Or we may see a stock struggling to get past a strong resistance. Taking a short position is the only way we can profit from both these situations.
Here’s how short selling works. Assume you want to sell short 100 shares of a company because you believe sales are slowing and its earnings will drop. Your broker will borrow the shares from someone who owns them with the promise that you will return them later. You immediately sell the borrowed shares at the current market price. When the price of the shares drops, you “cover your short position” by buying back the shares, and your broker returns them to the lender. Your profit is the difference between the price at which you sold the stock and your cost to buy it back, minus commissions and expenses for borrowing the stock.
Analyst usually tells that there is no need to short. They’ll tell you not to worry about short-term fluctuations in the market. But the point is that most bear markets start with a tiny innocuous intra-day blip that grows and balloons. And before you know it the bears are on the rampage, tearing your portfolio to shreds.
Why sit through a correction where your portfolio has the potential of losing, say, 10% of its value when you could possibly generate a positive return during the same period? Then, when the market turns up, you can get back to the long side and participate in the next leg of the bull market. It does sound like a smart thing to do, doesn’t it?
But does that mean we react to every intra-day blip that pushes down prices. God! No. That’s a sure-fire, time-tested, quality-checked, guaranteed method of committing financial hara-kiri. As is the case with every trade, even a short call is put out only if the risk-to-reward ratio makes sense.
Short-selling stock is an extremely high-risk transaction. The potential gains are limited while the potential losses are unlimited. That’s right. Losses tend to infinity!
Successful short selling is all about timing, which makes it more like technical analysis than fundamental analysis. Short-selling provides a way to speculate if you think a market’s value is going to decline. This allows you to add value to your portfolio even in a bear market. Without short-selling, it can be very difficult to make money from a downbeat market.
Sometimes economic events or published financial problems can lead to a decline in the value of a company. Short-sellers tend to look out for these fluctuations in the market, hoping to make a profit as the price dips.
If you hold a number of long positions, you may choose to protect them with short positions. This is known as hedging. So yes short selling can be a blessing to protect the portfolio
Risk with taking short positions is that stock prices tend to rise over time. Betting whether a stock’s price will go up or down is not like flipping a coin. The odds are not even. Over the long term, stock prices on average do tend to trend up.
So to keep a long story short, short selling can be a very profitable strategy to play the downside, it comes with so much risk that the losses could wipe you out of home and hearth if not handled with discipline and the right kind of tools. Like putting stop losses.
BY- RACHAT GAUTAM
Rachat is a student at SSCBS, DU. The views expressed are based upon the analysis and research that the writer did on the topic from various books, reports and web articles. The writer regularly writes for Corporate Monks as a research associate. The writer takes personal responsibility for the ownership of the content shared and incase some sources have not been given credit, you can directly mail the writer firstname.lastname@example.org