Shorting A Stock: Explained
In finance, short selling is the practice of having investors sell assets, usually financial securities, which have been borrowed from a third party (usually a broker) with the intention of buying identical securities at a later date to return them to that third party. The trader expects to make an economic profit from the hypothetical future fall in the price of the securities, since he returns the same amount of securities he borrowed, but not the same monetary value. If, on the contrary, the values rise, it would suffer a loss.
When making short sales, there is a risk of losing even more than 100% of the negotiated capital, since the shares do not have a ceiling that limits their increases.
That is, those who buy shares in a normal operation, the biggest risk they can face is to lose all the amount they initially invested. In the case of short sales the losses can greatly exceed the amount of the initial operation.
For example, if you make a short sale of a stock to $ 1,000, the buyback period may come to $ 2,500, implying a loss of 150% for who owns the stock.
The profit limit is also unfavorable. In a traditional stock purchase, the value of such shares can be multiplied numerous times, multiplying the initial investment. However, in a short sale the limit of earnings is the price of the shares, since the shares do not have negative prices. That is, in an ideal scenario, the investor makes a sale of a stock of $ 1,000 and repurchases it to $ 1, for a gain of 99.9%. However, it should be noted that there was actually no initial investment, since the securities they sold took them on loan.
Short sales are mainly engaged in short-term operations to take advantage of the fact that markets tend to experience price falls faster than their price increases. However, the fact that most financial markets have a long-term upward trend and their greater exposure to a limited gain compared to traditional purchases limits the use of sales for long-term investments.