Short Selling 101: How-tos, Pros and Cons

Short selling is an advanced investment strategy for experienced investors and traders to profit from stocks that decline in value.

It flips the conventional idea of investing i.e. buy low and sell high. Conversely, it is "buy high and sell low", betting that the stock price will decline. The trading is done through brokers that offer this service. To short a stock, investors need to first initiate a position by borrowing shares from a broker and you must buy the shares back in order to close the trade ideally at a lower price to repay the loaned amount to the broker.

If the price drops after the investor short sells the stock, the investor will then buy it back at a lower price and then return it to the lender. The difference between the sell price and the buy price will be the investor’s profit.

If a stock’s price increases, the investor will lose money. One of the biggest risks of short selling is the possibility of losing an infinite amount of money as there is no ceiling as to which a stock price can rise.

Short selling can be a good investing strategy to earn money in bear market. Investors who short sell in a falling market can earn a positive return. First, short sellers borrow shares of stocks from a brokerage. Then, they sell the borrowed shares at current market price and receive the income earned from the shares sold. Short sellers would then have to decide whether to close out the short sale by buying the exact number of shares sold to return to the brokerage, in the hope that the stock price would drop when they buy the shares such that they can earn the price difference.

For example, if an investor thinks that ABC stock is overvalued (current price: $150/share), and its price will drop. He or she can employ the short selling strategy to make profit. The investor needs to borrow some shares, say 10 from their broker and then sell them. 

If the stock does go down to $100, the investor could buy the 10 shares back at this price, return the borrowed shares to their broker, and make $500 profit ($1,500 - $1,000). However, if the share price increases to $200, the investor would have to pay a higher price to buy back the shares borrowed, making a loss of $500 ($2,000 - $1,500).

Please beware that short selling is high risk trading strategy and does not guarantee profits.

An inverse ETF is an exchange traded fund (ETF) consisting of different derivatives with the objective of delivering inverse returns of underlying indexes. Inverse ETFs only seek investment results that are the opposite of their benchmarks' performances for one day only. For example, if an inverse ETF seeks to track the performance of Nasdaq 100 index. Therefore, if the Nasdaq 100 index goes up by 1%, the ETF should drop by 1%, and the opposite also stands.