Short selling is highly profitable trading technique which involves tremendous amount of risks. That’s not all, traders need to be extremely careful with their margin requirements and ensure that trades are done as per short selling rules. We all know that stock investments can lead to unlimited risks, so short selling was primarily introduced to safeguard investors against sudden market reactions and corporate actions.
Short Sellers very often face hard criticism for the role that they play in the markets; many wish that such people never existed. But, what we cannot ignore is the fact that short selling helps in creating a healthy investment environment. Short selling plays an important role in boosting liquidity, which is necessary for efficient functioning of price discovery mechanism. Above all, it’s always better to have contrarian expression in the system, so that stocks and markets do not climb-up from bullish trajectory to bubbly levels.
Traditionally investors had just one option i.e. “Buy Low & Sell Higher”. The main problem with this strategy was that volumes simply dried up when stocks went overpriced, so there was a dire need for a short selling mechanism.
Short selling is a trickier option as it is completely opposite to the traditional investment approach. This complex trading strategy involves figuring out overpriced levels in stocks and indices and then selling what you don’t own in anticipation of a fall. The important part here is that investors have to buy their short positions before the contract expires.
If you want to initiate a short position in a stock, then you should use your trading platform to borrow stock from the open market and then put it to sale at desired price. All you need to strategize is to buy back the sold position before the contract expires and make a profit out of it. In this process you never actually take the ownership of the stock you sell and then buy to close the deal. Now, the key risk in this strategy is that the stock you sell might continue to rise throughout the contract term, and this may lead you into severe or unlimited losses. So a stop loss is mandatory while you adventure through the short selling way.
What’s wrong in it if you want to sell a stock that you feel is overvalued, when you do not hesitate in determining which stock is undervalued?
You need to contact your broker for upgrading your account and enable short sale. This feature is available after you are subscribed to a margin account with most brokers. It might require some minimum account balance to start with along with some necessary paperwork. You must opt for a reliable broker who ensures effective account monitoring so that you do not end up suffering unlimited losses in bad trades.