Shorting a stock has been popular and widely accepted investment strategy in past years. It had become increasingly globally known when Bill Ackman and David Einhorn, two of the most remarkable names in the investment industry, pulled off major bets against the biggest companies in the stock market, which triggered investors’ interest in short selling.
Shorting a stock, or commonly known as short-selling, is a technique of investors in which they sell the shares they do not own. A broker, or a third party, makes it possible by buying the stock and lending it to investors. The borrower will return the stock when its price falls down to profit from the difference in its original price or will have to buy the stock at a higher price at a loss if price goes up.
Traders have found a great way to rise in lows by making extra money even from a falling market. By shorting a stock, they are able to speculate on stock prices or use it for the less risky hedging purposes.
Speculation, meanwhile, entails higher risks given the short time frame of the trade because most speculators only hold their selling position in a span of weeks to few months. But when the company’s shares sustain its declining price, it adds more value to your portfolio.
If shares prices go up after shorting a stock, investors may not worry as they can place a buying order and return the stock to the lender or the broker, closing the short position.
Shorting a stock can also use to protect your investment portfolio through hedging. Normally, investors with long positions capitalize on short selling to protect their stocks. This less riskier strategy does not aim to gain any profit but only to safeguard other investments.
Hedging is like investing in an insurance for your property, such as your car or house. You can utilize, for example, a derivative contract (like futures) in the stock index to pull off short positions in times of downward movement from your long position on blue chip stocks.
Shorting a stock gives relief to investors in times of bearish market. While it allows traders to speculate or hedge, this activity also has its downsides and restrictions. For instance, you can lose more than 100% of your money if prices sustain an upward trend. Additionally, short selling is not possible if stock owners are not willing to lend.
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