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How to Short Stocks and Other Assets: The Guide

Adam Lienhard
How to Short Stocks and Other Assets: The Guide

Short selling is a trading strategy where the trader aims to sell high and buy low, in contrast to the traditional approach of buying low and selling high. The strategy requires experience and involves speculating on the decline in the price of a financial instrument. However, short selling is suitable for mature investors. In this article, you will learn the basics of shorting.

Why sell? Advantages and disadvantages

You quickly profit from the market decline.It is effective mostly for experienced traders.
It helps to hedge long positions.The price moves unpredictably and may cause losses.
It can be used with any asset: stocks, currencies, crypto, etc.The importance of risk management is much higher.

How short-selling works

In the traditional method of short selling, traders borrow assets they don’t own from their financial broker. The borrowed assets are then sold at the current market price. The trader’s goal is to repurchase the same assets at a lower price and return them to the lender. 

If the asset price decreases, the short sellers benefit from the price difference between the borrowed price and the repurchase price.

For instance, in September 2023, the shares of Netflix were trading at $446 per share, which you believed was overvalued. In anticipation of a decline in the stock price, you decided to sell the stock short. In mid-October 2023, the shares were trading at $351 – your shorting brought you profits. 

Two ways to short stocks

When it comes to short-selling, there are two main methods you can use:

In technical analysis, investors use trendline indicators like Ichimoku Cloud, MACD, RSI, or Moving Averages to determine the overall trend direction of a particular asset. 

If the trend shows no signs of slowing down, technical analysts can sell assets, leading the trend downward. 

They can also use chart patterns represented by Japanese candlestick formations or Western chart patterns, such as Head and Shoulders, descending Triangles, rising wedges, Double Tops, and Triple Tops to identify sell signals.

Fundamental analysis, on the other hand, focuses on a company’s financial health and other factors that may impact its stock price. 

1️⃣ Earnings reports, for instance, can be a significant opportunity for short sellers. When a company’s profits fall short of earnings estimates, it is likely to underperform during certain times, causing a large number of investors to start selling short. However, it is essential to look beyond just earnings reports, as a company’s performance may be weak for reasons that do not affect its stock price.

2️⃣ Declining industries also offer short-selling opportunities. Industries that have experienced a general slowdown due to innovations in other markets or negative customer sentiments can cause the price of a stock to decline. This can also be influenced by political and economic events such as presidential elections and trade wars. When an industry is considered to be outdated, companies in that competitive space may have diminishing growth prospects, allowing short sellers to benefit from this weak growth.

3️⃣ Overvaluation is another factor that can lead to a gathering of short sellers based on that valuation. Stocks that are consistently in the news and overhyped can become excessively inflated compared to their actual value. Once a stock market bubble bursts, short sellers will gather to sell these stocks because their current value does not match their true value.

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