Are you interested in short trading stocks? Good. Because you’re about to get an introduction on how to go short on the stock market.
Since short trading stocks quite literally is the opposite of “traditional” trading, you have to understand the difference before you get started. Everything from the way you trade stocks to the way you analyze them and place positions is different when shorting stocks.
But there is no need to fret. We’ve done our due diligence and asked our day trading experts to create a guide for short trading stocks. So without further ado, let’s have a look at the characteristics of shorting stocks in 2021.
What is Short Trading?
Let’s start with the basics and answer the question on everybody’s mind: what does short trading stocks mean?
Short trading is the concept of speculating on instruments and assets that are decreasing in value. In other words, your job is to find a security – in this particular case a company stock – that you expect will decrease in value over a certain period of time.
To do this, the trader “borrows” the stocks from a broker then sells the stock for a lower price before buying it back and returning it to the broker. It might sound complicated at first, but it’s not really. Also, when going short on a stock, your broker will handle the process for you.
Is Short Trading Legal?
Yes, it is legal to short trade stocks. In fact, short trading is fully regulated in the UK as well as the rest of the Western World. As mentioned, certain brokers limit their short trading options. Although, if you pick one of the top UK CFD brokers, you can rest assured that you can short trade at will.
In extreme conditions, an exchange (and/or a broker) can limit short trading on a specific company stock. A good example is when short trading airline stocks was stopped due to the COVID 19 restrictions and the huge hit that the travel industry took at the time.
Analyzing Stocks when Short Trading
There are many ways to analyze a market when going short. For beginners, the goal should be to find stocks that seem overbought or overvalued as well as companies that are underperforming.
In addition, you can analyze the market using a range of more technical strategies. To learn more, we advise you to visit our more in-depth trading strategy guides.
Long vs Short Trading Stocks
We’re often asked if it’s better to go long or short on the stock market, but there is no straight answer to that question. Both strategies have their pros and cons.
With that being said, long positions are, by far, the most popular on the stock market. It’s also the most common way for investment companies and institutions to invest in stocks. The main reason for this is that it’s slightly easier to predict when a company will excel than it is to predict when it will fail.
Also, companies are run with the intention to grow. Therefore, shorting stocks means you’re constantly working against the market. At the same time, there are many examples of successful short traders that have outperformed their long trading peers.
Short Trading Made Easy With Derivatives
When short trading stocks off a stock exchange, your broker will handle all the “work” behind the scenes and ensure that your short positions are honoured. However, due to the extra work needed to place a short position, most traditional stock platforms limit short trading.
Luckily, derivatives trading such as CFDs and spread betting makes it just as easy to open a long position as short. Thus, short trading stock derivatives is much easier than short trading actual stocks off an exchange.
For instance, when trading stocks as CFDs using one of our recommended UK Stockbrokers, you can pick to either open a buy (long) position or a sell (short) position on any underlying asset.
Better yet, the process for short trading CFD stocks is the same as when trading long positions. Therefore, we suggest that everyone interested in shorting stocks, consider using derivatives to do so.
Hedging with Short Positions
In addition to being a potentially profitable method for experienced traders, shorting stocks is also used as a method of hedging.
Hedging is the act of opening a position to compensate the risk for another open position. It’s a traditional risk-management strategy that’s been used for as long as short trading has been allowed globally.
Short Trading Stocks: A Moral Dilemma?
There is a growing number of people and governing bodies that are increasingly sceptical to short trading, claiming it’s unethical to financially benefit from companies that are struggling.
Even though we understand these concerns, we’re also supporters of a free market where trading is only limited to increase trader protection.
In the end, it’s up to you whether you think that it’s unethical to short trade stocks or not.
Don’t Forget Tha Shorting Stocks is a High-Risk Way of Trading
Since any instrument, in theory, can increase unlimited, there are huge risks involved in short trading. Because of this, it’s recommended that you always use stop-loss on your positions. That way, you can easily cap the losses you can make on each position.
Furthermore, short trading is not nearly as popular as long positions, meaning there are fewer resources available to learn all the necessary skills.
Our point is that it can be a lot more difficult to analyze instruments that may be declining than it is to analyze an asset that’s on a bull run.
With that being said, all forms of trading are associated with risks and many experts argue that short trading is not riskier than other forms of trading using the same instruments and/or derivatives.