This is a question we hear a lot here at the Academy and it’s a very simple concept when explained in the right way.
In simple terms short selling is the practice of profiting from a market that is falling in value. This can be a stock market, equity, forex pair, commodity or bond. We can engage in this practice through the means of a CFD (Contract for Difference) which gives us exposure to an underlying asset without ever physically owning it.
During the global financial crisis, we heard this term used every day as equity markets were in free fall and financial institutions were preying on companies to short in order to profit. At one point there was even a ban on shorting financial stocks. Fortunately, in today’s markets there are no bans on short selling and there are many opportunities to profit from falling markets.
The important point to remember here is every CFD trade has two sides – a buy order and sell order. When we buy (long) we anticipate the market will rise in value and we hope to exit this trade (sell/short) at a higher price in order to profit. When we believe the market will fall in value we can do the inverse. We sell first (short) in anticipation of buying back (long) at a lower price in order to realise a profit.
So let’s look at a worked example. Today the price of Apple stock is $105 so if we believe the price of Apple stock is likely to fall over the coming days or weeks we can sell (short) Apple stock at $105. Let’s say next week the price of Apple stock falls to $99 and we decide to exit the trade, we simply place a corresponding buy (long) order to exit the position. We have fulfilled our obligation of closing the trade as we have placed both sell and buy orders managing to realise a profit.
It’s important to note that having a trading strategy is key as we must have an equal balance of longs and shorts which act as a natural hedge to one another when choosing a diverse portfolio of inversely correlated markets. We assist our traders during the asset selection phase to ensure they have a diversified portfolio of assets in order to help them achieve their objective of trading profitably in a risk averse sustainable manner.