Short selling in stock trading refers to the practice of "borrowing" a stock from a broker, then selling it at a reduced price when the share decreases at a later date. It requires the investor to assume the risk that the share price will increase instead, resulting in a shortfall.
Short Selling Methodology
When you short-sell a stock, your broker transfers the requested shares to your account, then sells them on the market. You receive the financial benefits from the sale. At a later date, you must cover the short sale by repurchasing the shares. If the share price has decreased from the original sale, you keep the difference.
Holding Onto a Short
Unless the lender calls the short, an investor can hold a short position as long as he or she wants. Practically speaking, however, the duration of a short depends on the potential for profitability.
The investor must keep tabs on the market to determine whether a short will continue to drop in price. If it shows signs of rebounding, the investor should end the short sell and eliminate potential losses.
The Risk of Short Selling
The primary risk of short selling lies on the volatility of the market. A stock projected to decrease in price could suddenly rebound, which might result in significant losses.
Furthermore, holding a short position for a long period of time could result in high interest charges, according to Investopedia. Theoretically, interest charges could exceed the profits realized from the short position, resulting in an overall cash loss.
If you're tired of playing guessing games with your finances, sign up for Mint and take control of your money. Use Mint to track your investments as well as your other financial metrics.