The Basics - Short selling
The most common way to make money on stock markets is to buy when prices are low and sell when prices are high.
In a rising market, you make money when markets are going up by buying first and selling later.
However, if markets are falling, how does a trader take advantage of that?
A swing or trend (click here to refresh your memory) in prices is what we are looking for. The trend can be upwards or downwards.
To make money when markets are going down, we follow a process called Short Selling - A concept most people find particularly tough to understand.
Let me tell you a short story.
In the past, bear skin was used to cover up and protect against the harsh snowy winters in certain cold countries.
There used to be a group of me, bear skin traders, who at the start of winter would go to villages and start collecting orders from people for bear skin.
People used to pay them first at the time of placing the order so they could buy their tools and traps to hunt bears.
And by the end of the week, these men would return and hand over the skins to the people who had paid them for it.
Notice two things:
1. The men effectively sold bear skins before even having them. They sold what they didn't have.
2. They had to then hunt and get bear skins later and deliver them to the people who had paid them money.
So now, let's return to the stock markets and break down short selling. In simple words short selling is 'selling what you don't have'.
First off, you need to know that short selling is to be used only when trends are downward. Why?
Here's an example:
Say price now is 100. And in the future maybe it will fall down to 75.
If the trend is downward, it means in the future, prices are going to be lower than they are right now.
So if you bought now at 100 and sold later at 75 you'd lose money. So you'd just not do anything and wait for a new trend.
But if you had to, how could you make money in a down trend? What if you could sell first and buy later?
That's exactly what you do in short selling.
First you sell the stock at the current price of Rs. 100
And after a while you buy it for Rs. 75!
In trading it isn't necessary to buy first and then sell. You could sell first and then buy.
There's nothing too complex to short selling.
It just takes time to get used to the idea that you can sell something you don't have.
Just go back to the example of the bear skin traders.
When they collected money from the people - They sold first.
When they delivered the actual skins - They had hunted later.
Similarly, in short selling we sell first and then hunt for a lower price to buy and pocket the difference. Simple.
Take your time. Think about this for a while and let it sink in. When it clicks you'll remember this concept forever!
In the next few posts, we will be building up further on this topic and so it is crucial to understand short selling.
In the mean time, feel free to Subscribe and share this with others!
Do follow me on Facebook and if you like, you can initiate conversations with me over there!
See you at the next post.