What does it mean to short on the exchange? In a nutshell, it means profiting from falling prices. Shorting comes from the English word “short” and longing comes from “long”.
Another term commonly used in the literature for traders is “short selling”.
In the following part of the article, you will find more information about stock shorting and examples for beginner stock traders:
What is shorting in simple terms
Let’s imagine the following situation.
You sell watermelons at the market: you buy them in bulk from a car for $1 per watermelon and retail for $2 during the day. Your profit is a dollar per watermelon sold.
Suppose you have a partner at the same market who also sells watermelons.
One evening you have sold out all the watermelons for $ 2 apiece. Suddenly, a regular customer comes to the market and says: “You must save me, my wife wants a watermelon! Help me out.”
You know that your partner still has some watermelons left, you borrow one watermelon from them and sell it to the client for $2. The car with watermelons for 1$ arrives in the morning, and you return the debt of 1 watermelon to your colleague. Your profit = $1.
This is called shorting. The idea of trading at the market and on the exchange is the same.
What does it mean to short and to long
Strategy 1. Longing
Strategy 2. Shorting
Step 1
Buy at 1$
Borrow and sell at 2$
Step 2
Sell at 2$
Buy at 1$ and pay back
Profit
1$
1$
Strategy 1. Longing
Step 1: Buy at $1
Step 2: Sell at 2$
Profit 1$
Strategy 2. Shorting
Step 1: Borrow and sell at 2$
Step 2: Buy at 1$ and pay back
Profit 1$
The second strategy is more complicated because an extra person appears – a creditor. The one who lends watermelons, stocks, futures.
However, it does not really complicate trading on the exchange: the processes there are automatic, organized by the exchange and under the control of the relevant state regulators.
Example of how to short on the stock market
Let’s have a look at a weekly chart of the AAPL stock:
Let’s suppose that:
You noticed a spike in high volumes. You watched the news that was very bullish at the time and assumed that a buying climax was occurring in the market.
You built a market profile and saw active trading above $170. Perhaps a major trader used good news that attracted a lot of buyers to sell off his/her shares.
The price went down from the range with high volumes. It confirmed the hypothesis that the major trader was preparing for a period of falling prices.
The price rose again above $170 per share. However, the volumes were low, the candle was narrow and had a long upper shadow. It looked like a signal of demand weakness. It is likely that the major trader used the false bullish breakout (he lured the buyers into a trap and knocked down sellers’ stop-losses) to build an even more significant short position.
You have enough evidence to justify AAPL stock shorting on the candle that follows candle №4. To find a better entry point, you can switch to the intraday time frame and apply advanced indicators of the ATAS platform.
Your broker confirms that shares are available for short selling. You borrow shares, sell them (let’s say at $172) and hold the position to pay back later at $152, for example.
FAQ about how to short on the exchange
Who are short and long sellers?
Traders’ slang words. Short sellers have a short position. Long sellers have a long position.
What shares can be shorted?
Not all shares can be shorted. The list of available shares for which you can open short positions is usually presented on the broker’s website. As a rule, these are well-known securities that have a liquid market. If the share is unknown and is trading “weakly”, the broker probably will not allow you to open a short position because he increases his risk in this case. Shorts can only be held intraday for some shares, while for others, it is allowed to carry shorts through the night.
How does the broker benefit from lending?
The broker lends at interest. As a rule, it is small and does not really affect the final financial result. By lending, the broker blocks the corresponding amount on your account, which serves as security (collateral) for the position. Usually, it is 30% of the value of borrowed shares.
What are the risks for short sellers?
Potentially unlimited losses.
If you buy one share for $100, your maximum risk per position is $100. If you borrow one share and sell it, there is a risk that its price can rise to 1000, 10k, and so on. To maintain a position, you need to constantly deposit money into your account. There are greater chances that this money will be lost.
Where does the broker get shares to lend?
Usually, the support service gives a standard answer: “From our partners, there are reputable investment banks among them.”
The fact is, this topic is not entirely transparent. It stimulates various conspiracy theories about who really owns the shares traded on the stock exchange.
Can one short with leverage?
Yes. Usually, the broker allows opening short positions with leverage. The more popular and liquid the share is, the higher the leverage is allowed.
How to make money trading futures?
It is a great option to trade in bull and bear markets. Thanks to the convenient trading interface of the ATAS platform, you can short stock market indices in 1-2 clicks and profit from falling prices.
How to short cryptocurrency?
You can’t sell bitcoin if you don’t have it on the spot market of a cryptocurrency exchange (like Binance). However, it is very effective to short a falling market on the futures market (there are plenty of them and they have sufficient liquidity).
What is a short squeeze?
A short squeeze happens when short sellers have to close their positions at a loss because they made a mistake with the forecast and the price went down.
Figuratively speaking, you borrowed a watermelon in the evening and sold it for $2. A car arrived in the morning and brought watermelons not for $1 (as usual) but for $3. You have to buy at a higher price and repay the debt at a loss.
When a significant number of short sellers close their positions, it accelerates a price rise because the market suffers a severe supply shortage. It is called a short squeeze. You can find more details in this article.
What other sources can you use to learn about shorting on the stock exchange?
Watch “The Big Short” about Michael Burry. Read “Reminiscences of a Stock Operator” about Jesse Livermore, also known as “The Great Bear of the Wall Street”.
How to start shorting in the stock market?
Make sure your broker allows you to open short positions for the stocks you are interested in.
Learn more about the broker’s conditions for shorting stocks.
Make sure you have chosen a short trading strategy that is profitable in the long run. Assess your risks.
A slowly growing bullish trend (the growth of the S&P 500 stock index is about 6-7% per year in the long term) is an important characteristic of the stock market. Even though a decline of stock prices happens less often, it is much more rapid.
To gain an advantage in your vision of the market, use volume analysis tools. They will help confirm entry into a short position.
Download the free version of ATAS right now! Try a powerful cluster chart analysis tool for stock, futures and crypto markets.
Conclusions
Those who short stocks profit from falling prices. They borrow an asset, sell it at the current price on the exchange, buy the asset back at lower prices, repay the debt and make a profit.
This is a difficult task, but professional indicators for volume analysis make it easier.
Download ATAS. There are four good reasons for that:
It’s free and you can continue using the program even after the 14-day trial period.
You will be able to identify signals for entering a short position in the stock, futures and crypto markets.
There is a demo account built into the ATAS platform, so you can practice trading without risking your real capital.
Information in this article cannot be perceived as a call for investing or buying/selling of any asset on the exchange. All situations, discussed in the article, are provided with the purpose of getting acquainted with the functionality and advantages of the ATAS platform.
