How to Become a Short-Seller
Many traders will take a bad trade going long and think: 'If I had just done the complete opposite everything would have worked out?' Contrary to popular belief, traders can actively day trade stocks moving to the downside. Most people won't because they don't understand how to short or that this method of trading exists. But it is possible, so here's a quick guide to get started.
What is short selling?
What: investors or traders who believe that the price of an asset will decline and are able to create a “short” position through the mechanism below. Shorting stocks is the opposite of taking “long” positions which is where investors and traders believe the price of an asset will rise.
Why: they think the asset price will decrease.
How: Much of this happens behind the scenes, but the mechanism for short selling is that investors or traders first borrow an asset and immediately sell it. Then their goal is to buy the asset back at a lower price and return the borrowed shares to the lender (in this case, assets usually means a specific stock).
Example: an investor believes that $MSFT will depreciate in value. They borrow 10 shares at $300 for a total cost of $3,000. They immediately sell the asset for $3,000. The stock price then decreases to $250. They buy 10 new shares at $250. Each share depreciated by $50 (or 16.6%). Because they shorted the stock, they made a return of $500. ($300 x 10) - ($250 x 10) = $500
What are locates?
In a perfect world, when going long: a trader buys low and sells high. When they short: a trader sells high and buys low. It's basically the complete opposite of going long.
But how can a trader sell what they don't already own?
Many stocks are easy to borrow, meaning the broker will allow you to sell shares you don't own for free.
Others require the trader to locate the shares from a broker for an additional cost. BUT many brokers will not have the locates needed on a daily basis.
More often than not they just don't have the inventory. Brokers that specialize in shorting, like TradeZero, are able to “locate” those shares for their traders.
Find the Right Broker
A man who works with his hands is only as good as his tools. A short biased trader is only as good as his broker empowers him to be.
A good broker for short-selling should provide daily locates and much more. A pro platform is also needed to manage everything in one place: from daily scans to a watchlist, level two and fast executions. Trading hot keys can also provide a trader with an edge.
TradeZero provides all of the above as a specialist short-selling broker. It has also consecutively won the Benzinga Global Fintech Award for Best Brokerage for Short Selling for 4 years in a row.
Managing Risk
It's no secret that day-trading can involve high elements of risk when not managed correctly. Choose a broker that offers all of the below methods:
Max Loss
Allows the trader to agree to a pre-determined max loss with their broker that when hit auto-liquidates the trader's positions. The broker, in effect, can take the trader automatically out of the trade at the next available market price when the max loss is hit. TradeZero executes a max loss when the agreed 'day total' is hit which is calculated as day realized plus day unrealized combined. This method can ensure losses don't spiral out of control due to the fact that the trader has failed to cut a loss themselves. For example, Trader X sets a max loss limit at $500 for the day with their broker. If an unrealized position of $500 occurs the broker should step in to cut the trade at the next available market price.
Stop-Market Orders
Are triggered when a stock moves past a pre-specified price chosen by the trader. Once the price point is triggered, stop orders convert into market orders executed at the best available price. For example, Trader X wants to cover his short position if the stock hits $5. The trader will place a $5 stop-market order. This ensures when the stock hits $5 the market order is activated to execute the trade at the next best market price.
Learn the Basics
If you feel more comfortable with the idea of shorting you can set up your account here. While completing this quick process, watch some free educational videos on the basics of shorting.
Make red the new green
Red in the markets does not have to mean red for your account balance.