Short trade is also referred to as shorting a stock, short selling or simply short. Short trade strategy is used when stock prices are droping. You make money by selling high and then buying low.
When a trader say, “I am short XYZ”, it means he has sold stocks of XYZ hoping that price of XYZ will drop.
To start short selling, you need to have a margin account with the broker. Therefore, you need to understand the terms and conditions of your broker before getting into selling short.
Process of short
Selling short is done by following four easy steps;
- You inform your stockbroker for short selling. Stock and number of shares to be informed along with other details.
- Your broker borrows the required number of shares from his own inventory or from another client.
- Your broker then sells the stock at current market price to give you money in your account. The amount credited will work like a loan. You need to pay interest and other costs associated as per the terms and conditions of your broker. If you short sell only during the same day, you need not pay any interest. Please note, you must return the shares of the company to your broker. Your broker does not want your money, they want their shares back.
- You buy the stock at a lower price and return the required number of stock back to the broker, who in turn will give it back to the original owner. By buying at a lower price, you make profit which is the difference between the amount credited as a loan minus the amount spent in buying stocks and expenses incurred.
All these steps takes a fraction of second to execute, the moment you execute a short transaction, your broker execute it if they allow to go short on that stock/securities.
In simpler terms, short trade means you are selling borrowed shares you don’t own in the hope of making profit when that stock’s price falls.
However, it has a flip side, there is no guarantee that stock prices will always go down as expected. If it goes up instead of going down, you will lose money as in such a scenario, you need to buy stock at a higher price to return it to the broker.
You will make a profit only if prices drop between the time you entered the agreement with your broker and when you deliver the stock back.
For example, you borrow 100 shares of XYZ company from your broker and sell them at Rs. 1,000 per share. After this transaction, share price of XYZ drops to Rs. 900. To make Rs. 100 per share profit, you buy back those shares at Rs. 900 and return them to your broker. In this case you have a profit of Rs. 100 per share. Now, what if the price of XYZ shares goes up to Rs. 1,100? In that case, you still have to buy 100 shares of XYZ to return to your broker becasue as per the terms and conditions you owe your broker shares and not money. Therefore, if you are not expecting price of XYZ to fall further, you need to buy 100 shares at Rs. 1100 in order to return shares to your broker, in this case you will have a loss of Rs. 100 per share.
If you have chosen a wrong stock while going long, you can at best lose 100% of your capital invested. But, in short selling, if the trade is not in your favour, you may lose more than 100% of the money you invest.
For instance, if you are long on a stock at Rs. 10 per share, the worst case scenario is that the company can go bankrupt and you will lose Rs. 10 per share. This means there is a limit to your losses. But if you short sell that company at Rs. 10 per share and then the price instead of going down, starts going higher and higher, then there won’t be any limit to your losses. You will not only lose your entire money, your broker might sue you for money if you do not have sufficient funds to cover your short position. That is why experts always suggest beginners to go long.
The potential for loss is unlimited. However, you can use stop loss order to minimize your losses. For that you have to be an expert.
Short selling works well in a bear market.
What is short squeeze
Assume for a moment that a lot of people are short on a particular stock and the price of that stock is rising. In such a case, these short sellers will run to buy the stock back so that they can return it to the broker by minimising their loss.
This mass buying will move the share price up. It puts a squeeze on the investor who had been shorting the stock, also known as short squeeze.
People go for short selling only when they think that prices are going to go down.
The most important thing to remember is that the process of shorting might be relatively simple, but it’s not easy to implement as you need lots of experience to understand the market. Which means short trades is not a strategy for inexperienced traders.
If you are a beginner, then better to stay away from short selling. After getting enough experience you can try it.
What is Long
Most people in the stock market easily understand making money by going long. Going long means you are bullish and seeking your profits from rising prices. It means buy low and sell high.
In simpler terms, when you hear a person saying he is going long, it means that the person will buy a stock and then wait for the price to go up in the future to realize profit. Its also called buying long.
If someone says he is already long on a stock, it means he/she has bought the stock and now owns it with an expectation that the price will go up.
When you hear a trader saying, “he is long 100 shares XYZ,” it means he has bought 100 shares of XYZ and would like to sell them higher for profit. When traders expect price to go higher, they go long.
By contrast, if a trader is saying he is going short, it means that person will borrow those stocks from someone, sell it in the open market, then buy stocks back to return the original owner, but he/she does not own them.
The main objective is to sell the stock for a higher price than your purchase price and reap a profit.
In trading if you own something, it means you are considered to be long. In other words, in long trades, traders purchase securities and wait to sell them when prices go up.
If a trader is going to own a security, then they may say they are “going long” or will “go long”.
When you go long, you will obviously expect the share price to rise in order to make profit. However on the flip side, share price may go down resulting in a loss for you.
Going long is a bullish action of traders, which means they have a belief that stock price will rise in value.
Don’t get confused between short-term trading and short trade, both are different. When the duration between buying and selling of a stock ranges from a few days to a few weeks, it’s termed as short term trading. If the duration is a few months or years, it’s referred to as long-term trading.
A trader goes long when he thinks that the stock is relatively underpriced and prefers to short when stocks are deemed to be overpriced. In the financial market you can buy and then sell the stock or first sell and then buy.
To understand price action you have to read and understand candlestick patterns formation and their interpretation within the market context.
Here is a list of most important candlestick patterns for your further studies;
- Evening Star
- Morning Star
- Bearish Abandoned baby candlestick pattern
- Bullish Abandoned baby candlestick pattern
- Three Inside up/down
- Three outside up/down
- Inside Bar
- Bullish Piercing
- Dark Cloud Cover
- Spinning Top
- Shooting Star and Inverted Hammer
- Hammer & Hanging Man
- Gravestone, Dragonfly and long-legged Doji
- Engulfing Candlestick Pattern
- Marubozu candlestick pattern
Be sure you practice identifying and trading these candlestick patterns on a demo account before trading them with real money.
In addition to the disclaimer below, please note, this article is not intended to provide investing or trading advice. Trading in the stock market and in other securities entails varying degrees of risk, and can result in loss of capital. Most investors and traders lose money. Readers seeking to engage in trading and/or investing should seek out extensive education on the topic and help of professionals.
