Short Selling, Part Four
Over the last few entries, we’ve taken quite a detailed look at the process of short selling, or selling stocks that you don’t own under the agreement that you’ll actually put up the money to buy them at a future date. In doing so, your hope is that the value of the stock will decrease and that the price you have to pay is less than the money you received by “selling” them.
Short Selling Is Risky
Of course, this is a risky proposition. There’s an awful lot that can go wrong, especially if the value of the stocks that you’ve short sold happen to go up rather than down. Let’s take a look at some of the major risks of short selling.
First of all, there’s the matter of historical precedent. Historically speaking, stocks do tend to go up rather than down. It’s just a general rule of thumb that has applied to the market over the decades. Because the very nature of short selling involves the assumption that a stock will go down, you’re automatically working against historical precedent, so be aware of that.
Secondly, there is no limit to the potential losses when you short sell. Since you lose out on a short sell when the value of the stock increases, it’s entirely possible for that stock to skyrocket without limit. If that happens, you could quickly be ruined. On the other hand, the distance between the price you short sold for and zero is the maximum possible profit that you can gain.
Lastly, short selling automatically involves the practice of trading on margin. This entails the use of borrowed money, which is a risky proposition in and of itself even without the added dangers of short selling stacked on top of it. You might fall prey to sudden margin calls even, which is one of the most disastrous things that can befall a trader. Even if you’re right, it might take quite a while for your stock to decrease in value, and in the meantime, you’ll be sitting on short sold stocks bought on margin that are increasing in interest and ultimately costing you money.
Long story short, if you’re going to short sell, you need to be absolutely aware of all the risks that are involved. Of course, it’s not all about making of losing money. There are a lot of ethical concerns involved in short selling as well, that we’ll take a look at next time out.
See you next week for part 5 of Short Selling.
Sean Rasmussen
The Bullhunters Guide
Universal Wealth Creation © 2004 - 2008
Tags: bear market, Bullhunter, market, money, profits, stockmarket, stocks
