How do you make money from short-selling?
Curious about short-selling
Shortselling is a trading strategy used by investors to profit from the declining price of a stock or other asset. Here's how you can make money from shortselling:
1. Borrowing and Selling High: In a short sale, you initially borrow shares of a stock that you don't own from your brokerage firm. Then, you sell those borrowed shares in the open market at the current market price. This step generates cash in your account because you've sold shares at a higher price than you'll eventually buy them back for.
2. Waiting for the Price to Decline: After selling the borrowed shares, you wait for the stock's price to decline. This is the key to making a profit in shortselling. The goal is to buy the same number of shares you initially borrowed (referred to as "covering") at a lower price than what you sold them for.
3. Buying to Cover: Once the stock's price has fallen to your desired level or you decide to limit potential losses with a stoploss order, you buy back the same number of shares you initially sold short. This process is known as "buying to cover" or "covering your short position."
4. Calculating Profits or Losses: To determine your profit or loss from the short sale, you calculate the difference between the price at which you initially sold the shares short (selling high) and the price at which you bought them back to cover your position (buying low). If the buytocover price is lower than the shortsale price, you make a profit. If it's higher, you incur a loss.
For example, if you shortsell 100 shares of Stock XYZ at $50 each and later buy them back at $40 each, you would make a $10 per share profit (excluding any fees or interest charges). In this case, your total profit would be $1,000 (100 shares x $10).
It's important to note that while shortselling can lead to profits when a stock's price declines, it also comes with significant risks. Unlike going long (buying shares with the expectation of price appreciation), where your potential losses are capped at the amount you invested, shortselling carries the risk of unlimited losses if the stock's price rises significantly instead of falling. To mitigate these risks, many shortsellers use stoploss orders to limit potential losses and practice prudent risk management.