Falling stock prices and markets in a downturn are actually not good news. But with short selling, traders can also benefit from falling prices.
Falling indices and declining stock prices are not good news for traders – actually. But experienced investors who are willing to take risks can also benefit from falling prices and thus have more opportunities to make money on the stock market – regardless of whether the markets are up or down. We’ll tell you how this can work with short selling, also known as short trading.
A short sale is selling underlying assets that the seller has only borrowed at the time of the sale. The terms blank sales, short trading, short selling, shorting, or, colloquially, going short are used synonymously. The seller borrows underlying assets, which can be a foreign exchange or securities, for example, and sells them. The delivery deadline is in the future, by which time the short seller must obtain the sold values. He is speculating on a cheaper price than at the time of his short sale.
In short trading, a distinction is made between the cash transaction and the forward transaction.
There are basically three different uses for short sales:
A speculative transaction based on the example of securities would go something like this.
By lending securities, the short seller becomes the legal owner of security that he can sell at the current market price. In order to be able to deliver it, the seller must buy back the loan in good time. If the price at this time is lower than the amount he received for the security at the time of sale, he makes a profit equal to the difference. If the price has risen in the meantime, it will make a loss.
This is also where the high risk of short trading lies. While the maximum loss when buying a share cannot exceed the purchase price. A share cannot be worth less than anything. The short seller has to literally procure the base value by the defined point in time at any price. Thus, theoretically, the price can rise indefinitely, and the seller has no way of avoiding the purchase of the value. This means that the losses can move into dimensions that cannot be assessed beforehand.
The opportunity to take advantage of falling stock prices is tempting. And actually, it doesn’t sound that difficult. It should be said at this point, however, that short sales are not for newcomers to the stock market. Instead, it includes investment experience, a high willingness to take risks, and the knowledge of the high potential for losses, which can sometimes far exceed the money invested.
So do your research before you decide to trade short and only use speculative opportunities that you have fully understood – then you too can benefit from falling prices.
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