All Financial Wisdom

How To Properly Short A Stock

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Earning money in the stock market when a stock goes up is very easy. Simply buy stocks, wait for them to rise, and then sell them. The gain is obtained from the difference between the purchase price and the sale price. Everyone understands how this mechanism works. However you can also earn money when a stock goes down.

When someone invests waiting for a stock price to fall, it is said that he is taking a short position. In contrast, when you simply buy stocks waiting for them to go up, you say you have a long position. In general, long positions are well seen, but short ones not so much.

Therefore, if someone buys shares massively, it must be declared only when it reaches significant percentages, while short positions must be declared very soon.

The problem with short positions is that you are betting that the stock will fall. This usually implies problems for the company, dismissals, factory closures etc… There are some currents that say that short positions can affect the company and cause problems.

Others, however, think that short positions do not affect the company and that its viability is not affected by its evolution in the stock market.

How to do it

To short, the first thing you have to do is get someone to make a loan of shares. That is, the short investor has to pay someone to lend him the shares he wants to short out for a while. Once the investor has obtained the loan of shares, he sells them. Then he expects the stock to fall, he buys them back cheaper and returns them to his owner.

The profit comes from the difference between the sale price and the purchase price (less the cost of the loan).

On the one hand we have the strangulation (short squeeze), which occurs if there are too many short investors and we can not buy back the shares and return them to their rightful owners. And it also happens that losses can be unlimited: if someone spends $10 on a stock, the maximum that can be lost is $10; however, if someone shorts that same $10, and the company takes off in the stock market, there is no limit to the losses (for example, if the price goes up to $100, the investor loses $90 plus the cost of the loan.

Sorry if this seems basic but many people have asked of late, and our advanced trading techniques only make sense if you know the fundamentals.

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