How To Make Money When The Stock Prices is Falling?
Short selling and its risks. Why do Investors take short positions when prices are falling? When does short selling make sense? We talked about ways to make money while stock market prices are falling.
One of the ways to make money from a falling stock Prices is by taking a short position (short selling). Short position is a completely simple term. An investor borrows the stock and sells it, then buys it again and returns that share to the lender.
Those who take short positions invest money in the possibility that the price of a stock will decrease in the future. If the stock price falls after the debt is borrowed and sold, the investor pays off the debt by buying the same share at a lower price and giving it back to its owner.
For example, if an investor thinks that the price of Tesla (TSLA) is more than 315 dollars per share and the price will decrease, he can borrow 10 Tesla shares from a member representative (broker) and sell them at the market price of 315 dollars. If the share drops to $ 300, the investor can repurchase these 10 shares at this price and return them to their representative and earns a net profit of $ 15 per share.
However, if Tesla's share rises to $ 355, the investor would lose $ 40 in the same way.
Risks of short selling
The investor who makes a short selling takes relatively more risk. When an investor goes and buys a stock, the money he can lose is the most he has invested. So, if the above investor had bought Tesla stock instead of borrowing it at $ 315, the maximum amount he could lose would be $ 315 again, as the price could not go below zero. In other words, the smallest value any share can buy is 0.
However, when the investor takes a short position, they can in theory lose an unlimited amount of money because there is no theoretical upper limit on the stock price increase. As it is, it can increase forever. As stated in the example above, if the investor had sold Tesla for short and the price had risen to $ 355, the loss would be $ 40 per share.
Why do investors take short positions?
The short position can be used for both speculation and hedging purposes. Speculators use short selling to earn income from a drop in a particular stock or the market in general. Risk aversioners use this strategy to protect their earnings or reduce the loss of their stocks or portfolios.
Institutional investors and professional individual investors often use short selling strategies for both speculation and hedging. Hedge funds, known as the Hedge Fund, are among the most active users of short selling strategies and often use short positions against certain stocks or sectors to protect their long positions in other investment instruments.
While this strategy offers investors an opportunity to profit in a declining or neutral market, it should only be used by experienced and knowledgeable advanced investors due to the unlimited risk of loss.
When does short selling make sense?
Short selling is not a strategy used by most investors as the general expectation is that the prices of shares will increase. Although there is a natural downward trend in some periods, stock markets tend to go up in the long term. Buying and holding stocks is less risky than short selling to the market or a specific company, especially for investors who think long term. However, there are situations where it makes sense to take a short position: If an investor thinks that a company's stock is likely to fall in the short term, then it makes sense. Taking a short position especially for a company experiencing temporary difficulties is an example of companies that may make sense.