Short term trading
How you can make money on short term trading and why it is better for inexperienced investors to forget about this method.
An investor can earn on the difference in quotes in two ways. The first is a long position. In this case, the investor plays long and buys shares in order to then sell them at a higher price. A short term trading means that when trading securities, the investor earns on the fall of the stock. In this article, I will tell you how traders make millions on such transactions.
How to make money on depreciating stocks
A short position is of interest to the investor, since, as a rule, shares become cheaper faster than they rise in price, and with the right choice, the profit of a bear can be really serious.
To open a short position, an investor borrows shares from a broker against the security of money in the hope that the securities of this particular company are overvalued and their value will fall in the near future.
The investor then buys the shares at the current price and then waits for them to fall in price. It is assumed that when and if the share price does fall, then the investor buys the same amount of securities that he borrowed, but at a reduced price.
Before choosing a company whose shares can be shorted, a competent investor thoroughly studies its history, financial statements and finds the key risks that threaten the company.
The investor receives profit from the difference between the purchase price and the sale price. That is, you could borrow shares from a broker and sell them for $10. The stock then went down to $5, at which point you sold it. So your profit was $5. True, from this profit you will pay a small commission to the broker. In addition, if you suddenly return the shares when they pay dividends, the broker may require you to pay them too.
It is worth noting that selling shares from your own portfolio cannot be a short position. When you sell shares that you bought earlier rather than borrowed, you are closing out a long position.
Shorting pros
An experienced investor who correctly predicts the behavior of the securities of a particular company can earn very serious money on shorting. A textbook example of successful shorting is George Soros’s game against the pound sterling in 1992. Soros managed to earn $ 1 billion on the “black environment”.
What are the risks of short term trading
The problem is that a short position cannot be opened for a long period. This means that after the expiration of a predetermined period, you will still need to return the borrowed shares to the broker – regardless of whether the securities have fallen in price or not. Therefore, if the shares that you bought at $5 rose in price to $10, then in this case your loss, not profit, will be $5.
This is one of the main risks of a short position. When you buy stocks in the hope that they will rise in price, then your losses are limited – if you spent $100, and the securities fell to zero, then you will not lose more than $100.
In the case of a short, your loss can be anything, because the stock can rise in price from $100 to $1000, and you will have to buy them at this price in order to repay the broker.
An example is the recent situation with investors from Reddit. They specifically bought large quantities of shares of companies that, according to investment funds, should have become cheaper. Due to the actions of the participants in the popular forum, the value of the shares of companies such as the AMC cinema chain and the game retailer GameStop, on the contrary, began to rise.
GameStop
According to some estimates, shorts have lost about $5 billion due to the rise in GameStop stock alone.
Tesla
Another example of an unsuccessful short is the story of the relationship between investor Jim Cheinos and electric car manufacturer Tesla. Cheinos has been betting Tesla shares for five years. According to the investor, the first four years everything was not bad. Then in 2020 the shares of the company headed by Elon Musk have risen in price by 700%. “It was very painful,” admitted a well-known short who made $500 million shorting Enron stock in the early 2000s.
In addition, going short is not only risky for the investor, but also for the broker who lent you the stock. Therefore, the broker may set certain conditions for the borrower. For example, a broker determines how much money a client’s brokerage account must have in order to open a short position. Moreover, the broker can forcibly close a short position if the stock suddenly starts to rise. The share price at which the position can be closed forcibly is also negotiated in advance.
Another nuance is that not all stocks are open for a short position. The short trader’s choice is limited to the most liquid securities.
What is short term trading squeeze
Such a situation, as in the case of GameStop, can lead to a short squeeze.
A short squeeze occurs when the stock of a particular company suddenly rises in price, and several short sellers are forced to close the position at once in order to minimize losses.
This can push the price even higher, which will attract the interest of ordinary investors to the securities, who are also starting to buy. In this case, the remaining short sellers are forced to buy shares even at a completely unfavorable price. Thus, the price can rise for a long time, and short sellers will find themselves in a very significant minus.
How to protect yourself when use short term trading
It is better for a novice investor not to try to make money on a short position, as this is simply too risky an option.
To avoid big losses, experienced investors use stop-losses – exchange orders that allow you to automatically sell shares when they reach a certain price.
Also, the same rule applies to a short position as to investing in general – don’t invest more than you can afford to lose.
FAQ
What is short term trading, or short?
A short position, or “short”, means that when trading securities, the investor earns on the fall of the shares that he borrowed from the broker.
How much can you earn on shorts?
An experienced investor who correctly predicts the behavior of the securities of a particular company can earn very serious money on shorting. A textbook example of successful shorting is George Soros’s game against the pound sterling in 1992. Soros managed to earn $ 1 billion on the “black environment”.
What are the risks of a short position in trading?
The problem is that a short term trading cannot be opened for a long period. This means that after the expiration of a predetermined period, you will still need to return the borrowed shares to the broker – regardless of whether the securities have fallen in price or not. Therefore, if the shares that you bought at $5 rose in price to $10, then in this case your loss, not profit, will be $5.
Disclaimer: This article is not investment advice. Assess the risks yourself before making any investment decisions.
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