One of the primary reason why investors invest in the stock market is to make money. Investors at large study fundamental analysis to narrow down on the company to invest. Their premises of decision making is value investing. The core value of investor is always, “Buy Right Sit Tight”.
Trading is very different from investing. The core principles of investing do not apply to trading. To make money in stock trading a person has to think differently. They completely different ways to make money in the stock market. While investing is to build wealth in long term. Get dividends which are reinvested and companies growth would pay the investors. On the other hand, trading is continuous buying and selling of securities where the underlying can range from stocks, commodities, currency, and ETF. Trading is the practice of buying low selling high & selling high buying low.
A stock trader is looking to make a quick buck with taking positions for short term. Trading is an activity where the trader does Technical Analysis of the derivative to analyze the stock using indicators such as Moving averages, Trends, Stock Patterns, and Oscillators.
Investing is “Buy Right Sit Tight” where is trading based on the trader’s strategy the duration ranges from few minutes to few weeks. Based on the duration of trade the stock trading is classified into four different types of traders. The reason why they are classified is that of the different strategy used by different traders to make money.
- Positional Trader
- Swing Trader
- Day Trader
- Scalp Trader
The activity of stock trader where” Selling High Buying Low” (known as “Short Selling”) to make money in the stock market. Short selling, on the other hand, forms part of stock trading where a stock trader believes that stock price is going to go down.
- 1 Make Money Short Selling
- 1.1 Understanding Short Selling
- 1.2 Things Required to Start Short Selling
- 1.3 Example of Short Selling
- 1.4 Money Required to Short Sell
- 1.5 Short Selling in Derivative Market
- 1.6 Considerations While Short Selling
- 1.7 Disadvantages of Short Selling
- 1.8 Advantages of Short Selling
- 1.9 Making Money with Short Selling
- 1.10 Conclusion
Make Money Short Selling
If you are a regular newspaper reader you would have come across that majority of headlines in the newspaper are negative. This is a phenomenon in the newspaper, magazine and social media. This is negative bias largely found among the readers; psychologists’ term this as a collective hunger to hear negative news over the positive news. People remember negative news more than the positive news.
Negative News sells faster and the stock market is not spared.
Investors make money in rising market and the wealth is created over a period of time. Investors make money through buying and holding strategy. On the contrary, traders make money in rising market as well as falling market. Traders hold the stock for a shorter duration and take frequent profits.
Understanding Short Selling
Let us say you buy an apartment today for Rs. X and you hold it for a period of 10 years. Now you decide to sell the apartment and you ask the local advisors or real estate broker for the property valuations. They get back to you saying the price of the property is Rs. 2X or 3X. The value of the property over and above the value of Rs. X is the profit you have made from the sale of the property. In the entire process you have purchased the property first and then a decade later you have sold to make the profit.
In the above transaction, you bought property first and then sold. Short selling is doing exactly the opposite. First selling and then buying the stock. Trader to make money from the stock market Sell High Buy Low which is exactly the opposite of the property transaction above.
Still confused? I would give you another example which would explain better. You and your friends regularly buy onions. At times when either of you is traveling you tell each other to purchase on behalf of them. This time you are in town and your friend is not in station. Since you have been purchasing onion regularly you know that the price of the onion is now going to fall because of fresh corp coming. Your friend has asked you to buy onion on his behalf which he would require after 5 days when he comes back. You tell your friend that the price of onion is Rs. 100 which is today market rate and he confirm you to buy at this price. At Rs.100 you don’t buy onions from the market but you have sold it to your friend. Now the price of the onions keeps falling on a daily basis. On the 5th day, the price of the onion is Rs. 70 and you decide to buy for your friend. Now you have sold the onion first to your friend and then you have bought the same when the price went down. The process of short selling has resulted in you earning Rs. 30 which is the difference from Rs. 100 to Rs. 70.
If you are still not clear about short selling just keep in mind the following – When you expected the price of the underlying or the future to go down in near future you first sell and then buy later, by short selling you are selling first and then buying the stock since we follow the principle of Sell High Buy low.
Things Required to Start Short Selling
Demat Account This would be one of the most basic requirement to start short selling. Learn to invest in the stock market a step by step process. Opening an account will get you started but it is important that you learn to reduce your commission this will help you in long term; [B]eware of Little Expenses, A small leak can Sink a Great Ship“.
Zerodha as a discount broker, fill in your details and get a callback. Or choose any traditional broker if you are not comfortable using system and operate.
Once your account is up and functioning and you have transferred the required amount you are ready to get started. A guide Nifty Future will help your understand intricacies of getting started with trading in futures.
Example of Short Selling
Short Selling can be done in the spot market as well as the future market. But the short selling in the spot market is limited to intraday.
Let’s take an example. You have just read the newspaper and you find negative news and you are very confident becuase of this negative news the stock price of the ITC Limited is going to go down. You do not have any stock of ITC Limited in your portfolio nor you have bought it recently e.i. you don’t have ITC Limited in your demat account.
Now when you ask your broker to sell ITC Limited he obliged and sold the stocks. Or if you are having a trading terminal and you have punched into your terminal to sell the stock.
Now, one of the two situations can arise either the stock goes in the direction which you predicted making you some money or the stock might go up in the opposite direction making you a loss. Now before the closing of the market if you decide to exit the position either positive or negative it concludes intraday trade.
If you fail to close your trade during the same day then it would lead to short delivery.
In futures trading, you are not restricted to close your position the same day. You can carry forward your position till the expiry date of the position.
Money Required to Short Sell
Based on the Margin Money required for the underlying one can short a security right from Rs. 1000 to as high as Rs. 1.5 Lakh it all depends on the value of the security and the risk associated with it.
Every broker would have a page dedicated to the required margin amount. Most of the time margin money required is almost the same across all the stockbrokers unless and until there are certain special benefits given to certain clients.
The Margin money required for intraday short selling is much lesser than the margin required for short selling delivery.
Margin Requirement is marked to market any profit or loss would be adjusted against the margin requirements.
Short Selling in Derivative Market
Short selling in the derivative market comes with no limitations you can hold it up to the expiry date. The margin is the same as long positions and the Mark-to-market remains the same.
The two main uses of short selling in derivative market one are hedging and second, is to make money. Hedging is the process of taking opposite positions in the stock market to protect the investment from sudden price movements. A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.
In short, hedging is the insurance for all your investments. A portfolio of investments work well in a continuous bull run perhaps during the bear period the portfolio might perform below average. This can be avoided with “hedge” which acts as an insurance and shields your portfolio against misfortune.
Of course, short selling derivatives to make money.
Considerations While Short Selling
Liquidity This is the key to any derivative you are entering if there is not liquidity you might end up not getting the right price for your derivative. At times stock with very less liquidity might even end up not able to exit the derivative altogether. Having a huge spread could be another reason for not being able to get out of your current position which might at times lead to reduced profit or increased profit.
Aptitude In bull market even a newbie investor could make easy money since most of the stock perform well. Challenge is during the bearish market. The cost of hedging should also be taken into consideration. A short seller should understand the macro level and stocks sentiments which leads to fall and the rise of the price.
Situations During certain key occasions the volatility of the derivative or the stock changes drastically. Especially during the elections, company results, dividends, bouns, economic indicators.
Strategy Shorting selling cannot be haphazard without any plan or calculations. Having a well-backtested plan in place with clarity on entry and exit is the key to success in the stock market.
Risk When dealing with derivatives one of the most important aspects is dealing with volatility. Risk management forms one of the major and the most important aspect to be managed. Not having proper risk management in place could not only affect the derivatives position but also cost portfolio.
Margin Derivative contract is mark-to-market and hence enough liquidity throughout the duration of the trade has to be maintained.
Disadvantages of Short Selling
Unlimited Losses If you happen to purchase a stock the maximum loss you could make is when the price of the stock goes to zero. But in case of future, this is not the case since the underlying derivative price can keep rising. This could lead to continuous losses if not taken care of. But practically a simple stop loss could be enough to manage the loss possibility.
Margin Call In a situation of a sudden increase in volatility or measures from the government or ministry margin could be increased and you could be asked to add the margin amount to your account. Also, if the underlying or the derivative goes up your broker could start giving you calls for additional margin. If the additional margin is not obliged the broker has all the authority to square of the current position or all the derivative position.
Gap A sudden squeeze of buyers in the early traders could result in a gap up. A short sellers nightmare when such a situation arises. At times it also hits your pre-decided stop-loss. Then is when standard deviation should be put to use.
Advantages of Short Selling
Hedging/Insurance The reason to hedge could be anything from commodities, currency & stocks. If you expected to buy USD in near future and you would like to mitigate the future fluctuations you could hedge with currency futures. If you are an agro commodity trader and you are holding stock of a certain agriculture product which you expect to go down. The agriculture commodity expected prices could be hedged with short selling the futures. There are unlimited options through which you can protect your investments from expected loss.
Leverage One of the potential way of earning money from derivatives is to earn money from future anticipation bearish movement in the stock. You can earn from the underlying without holding any stock in physical. Managing stock has its own disadvantages which can be overcome with leverage.
Bear Market Similar to hedging but to make money only bear market is possible with a derivative. Since intraday trading in the spot market is risky.
Making Money with Short Selling
The reason why short selling is fancy among trader because the return which bull market achieves in few years the same is achieved in few months in a bearish market. The money is made fast in short selling compared to going long.
Some of the strategies for initiating a short sell are mentioned below.
A combination of moving average of different time series and crossover can signal the bullish and bearish. A shorter moving average when crosses above longer moving averages it is a sign of bullishness. Likewise, when shorter moving average crosses below longer moving average it is a sign of bearishness.
Tip: The Golden crossover when the combination of three moving averages is used to decide the bearishness or bullishness has more probability of success since three moving averages are used.
The most popular type of chart used among the chartist is the candlestick. Certain candlestick pattern is used to identidy the bearish reversal in the price movement. Some of the candlestick patterns are hanging man, dark cloud cover, bearish engulfing, shooting start etc.
A trading range breaks out is when the stock break the trading breaks on the lower side of the range which clearly indicates that bearishness in the trend.
Similar to candlestick pattern there is a chart pattern which can be used to predict the future price movement. Historically these patterns are created by various professional to predict the future price movement. Certain parameter needs to be kept in mind while using the reversal pattern. Some of the patterns are reverse head and shoulder, wedge, double top, triple top etc.
Paul Tudor Jones made an estimated $100 Million when he predicted Black Monday in 1987 and shorted the stock market: Using technical analysis and historical S&P data, Paul Tudor Jones correctly predicted that the market was going to crash in 1987, and proceeded to massively short stocks. The Dow plunged 22% and estimates put his gains from that trade at around $100 million. (Source: bigtrends.com)
Paul Tudor Jones is the best example when it comes to making money from a bearish market in the stock market.
“There is no training, classroom or otherwise, that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market.” —
Multi-Billionaire Hedge Fund Manager, Paul Tudor Jones
If you are an investor and trader and if you are not learning to short sell in the stock market you are allowing a lot of money go off the table.
Come back here and tell us about the before-and-after. I bet you’ll have something to say!
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