Short Selling Pros and Cons: Short selling has always been a controversial trading technique. There are both sides to the shorting coin, i.e. people against it and people supporting it. And, we think both the parties are correct in their point of view. You will soon know why we are saying this?
In this article, we would, in detail, discuss the main advantages and disadvantages of short selling trading techniques. Then, it would be your turn to decide on which side you are.
Advantages of Short Selling
1. High Profits:
The first advantage of shorting a stock is traders earn a significant hefty amount from it. Also, when everyone’s losing, you will be ahead of them. And, it’s easier than nothing if you know how to do it. High profit is because of the margin facility available with the short selling. One can trade high volume even with little money and earn big.
2. Little Capital Requirement:
Traders do not need capital when going short. Short selling works on the principle of leverage and, and you need to pay a small fixed percentage of the trade value, initially.
3. Hedge against Others:
No doubt, short selling works as a hedge against other stock holdings. Many traders use it to reduce their losses if by any chance the market falls. When the market crashes, every asset falls, and you can use shorting against them to cut your losses.
4. Profit from Overvalued Assets:
Most traders complain that they missed the trend or lost the opportunity of earning from a stock. Stocks often get overvalued because of excessive demand, when rumours or hype creates. Not everyone can profit from them as they are spontaneous. However, it is much easier to spot these overvalued assets as they are everyone’s topic for talk.
By short selling, one can profit from them quickly, as eventually, they would also fall to their original price.
Disadvantages of Short Selling
1. A Curse for Companies
Short selling a company’s stock can make it go bankrupt. There are live examples of it today. Bear Stearns, the largest US-based investment banking company, is suspected of going bankrupt because of the same reason.
The simple reason is if a lot of people will short sell a company’s stock, they would want its price to fall. And, as a result, the demand will get affected.
Fact: During the 2008 recession, the high profits from short selling signalled the depression in advance.
2. Unlimited Loss
There is no limit to the amount of money one can lose on short selling. When a trader buys a stock, the maximum he can lose is his investment. However, shorting is speculating; there’s no limit to how much a stock can rise. And, the more the price increases, the more the loss.
3. Against the Market
Short selling is going against the trend and the market. No matter what, the market is meant to grow, and it will grow. Although it is not a rare situation that the market falls; the market falls up to an extent only; it can’t just drop drastically. Second, the probability of days of the falling market is very less in comparison to the market rising.
It is common for the government and other regulatory institutions to interfere in the trading market if it falls beyond a specific limit. And, let us clear you that the limit is not very big, just a 5% drop can make them intervene in between and freeze the market.
5. High Cost
Even if you don’t suffer a loss from shorting or earn a little, the high cost behind shorting can eat you up, like a cheeseburger! No matter if you gain or not, you need to pay your broker’s commission, margin value, and dividend too, if it is a dividend-paying stock.
The last disadvantage of trading in short selling is wrong timing. You can indeed make speculations for over-purchased shares and then short-sell them. However, the overvalued assets do not come back to the normal in just a day or week; it takes time. Till the time it comes back, you have to pay the dividend and interest. Therefore, many times a losing situation.
At last, these were the pros and cons of shorting a stock. Any trader thinking of using the short selling technique must keep in mind all of them. Moreover, there are more cons than pros in this strategy. However, the one who plays smartly earns from them, anytime!
If you are a new trader and thinking of using this tool, then we would advise you to be a little wary! Compare each aspect along with your goals, and then make a rational decision. The stock market has always gone up in more extended time frames. Thus, never go short for a more extended period. Also, do not forget to keep in mind the several costs associated.
Short Selling Pros and Cons: Why we are telling you, again and again, the same thing is because most traders come, read, and trade. The shorting requires skill, knowledge, and strategies, along with experience. We have also seen experienced traders losing tons of money in short selling.
In the end, if you still believe in your guts, then all the best from our side!
And, may the market go in your favour.