What Is Short Selling?

What Is Short Selling?

Buy low, sell high: conventional wisdom says the only way to trade is to go long. But short-selling, going short or shorting is a way to trade if you think a market will fall. The aim: sell high, and buy low. But how can you sell something you don't actually own? Well let's take Rio Tinto. Imagine it's trading ad thirty four pounds per share. You think the price will drop, so you short sell a hundred shares at a value of thirty four hundred pounds. To do this, you effectively borrow them from your broker. If the share price does fall to say thirty two pounds, you can buy back all one hundred shares for thirty two hundred pounds, and return them to your broker.

The difference, two hundred pounds, your profit, less any fees or commissions. But if the price had risen to thirty six pounds, for example, buying back your shares would cost you thirty six hundred, and that would mean a loss of two hundred pounds plus costs. Remember you always need to buy the shares back at some point, as they still belong to your lender. Trading derivatives, like CFDs, makes the process of short-selling as straightforward as possible. You never own the underlying asset anyway, so short-selling is no more complicated than going long. So why do traders short-sell? The obvious reason: you can trade a market when it's going down. So bad news and price dips can become opportunities. Another: hedging, where you open a position that can counter adverse moves in your portfolio, offsetting your risk. For example, if you have long positions on several Nikkei 225 companies, you could use a CFD to short sell the Nikkei index as a whole, which could reduce the impact on your bottom line if your Japanese shares start dropping in value. So, short selling has its advantages, but there are potential downsides too.

Unlike going long, there's no limit on how much you stand to lose. If you buy an asset thinking it will increase in price, the absolute worst case is it drops to zero. But when you go short, the price could rise indefinitely. This makes it important to use stops to limit your losses. So the risks are there, but if you approach with care, the opportunities provided by short selling really can add another dimension to your trading. .


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