Short selling is kind of like placing bets on sports. Bettors are similar to traders as they assess and take risks as a trader does. When a team loses, or a company announces less than expected profits, bettors and traders are left holding worthless slips of paper. Or digital receipts.

Most people think that making money from stocks is about getting in on the ground floor and investing early, like supporting a small team that hits the big time. This is not always the case, and bettors know you can make more money betting against a team, sometimes, than banking on them for a win.

The truth is, making money off stocks doesn’t necessarily require them to rise in value. Investors can also profit when stock prices decline through a practice known as short selling. This practice is analogous to placing bets on sports teams that are expected to lose.

So, What Are Shorting Stocks?

Traders can borrow stock from brokers and quickly sell them. That’s short selling a stock. The trader is betting that the value of the stock will drop soon. Traders will repurchase the stock at its low point and return it to their lender. They keep the price difference as their profit, after deducting any borrowing fees or interest owed.

Short selling involves much more than just grasping the basic concept. The strategy carries the potential for substantial losses, and diving in headfirst is like placing sports bets and not taking the time to understand the teams’ performance or the sport. People are using high-tech tools to keep on top of market movements and stock performance and discover more about trades. Financial whizzes can trade shares on MT5 and keep abreast of the latest developments as if they are watching ESPN or a sports site.

How Do You Short a Stock?

To begin, you will need some form of what is known as a margin account. When a trader borrows stock, they are entering into a financial agreement with the stockbroker, and this agreement will include interest charges, fees, and potential penalties. Getting a margin account with a stock brokerage firm can take time, but many apps offer the use of their facilities, letting new traders make trades within set limits.

If the value of the shares takes a downward turn, traders will begin ‘closing’ their ‘short positions’ by buying back the stock for a cheaper price and giving the stock back to their broker. Before a trader can profit, they need to pay any fees or commissions, as well as any interest. This can take a big bite out of your gains if you are not careful and do not plan for it.

Why Would You Short?

Short selling is speculative, and it carries a lot of risks. With risk comes reward though, and short selling can allow a trader to reap huge rewards quickly, which is why so many people are attracted to it. Long-term investments require hours of analysis of a company’s financials, its management structure, and its future prospects. Short sellers monitor daily price movements, market signals, and consumer trends to divine daily profits from the markets.

Something called ‘short interest’ can be an important factor in short-selling trades. This figure is the volume of shorts open at brokers on any given day. It is usually a ratio or a percentage and is a number that expresses the volume of shares shorted over the volume of shares that can be bought on the open market. A larger ‘short-interest’ number lets traders know that people are not feeling good about the stock, and this is attractive to short sellers.

Can You Hedge by Shorting?

Many people use shorting stock to hedge other investments, protecting their wealth. If you own stock in a business or brand but think it will underperform in the short term and you want to keep hold of your stock, what should you do? In this scenario, you can hold on to your stock as a longer-term investment, while also entering into a short sell on new stock from a broker. You can buy it back when the value drops. This can be used to hedge against losses caused by your holding stock in the business.

In normal trades, you can lose the value of the stock when you bought it — that’s the limit of your monetary losses. Normal trades have unlimited potential for profit over the long term. Shorting stock flips the script. The price of the shorted stock could decrease to zero, or the price could go through the roof. The potential losses become unlimited, as traders need to buy the stock back at a higher price than they sold it for. This is how people lose it all on the market.

Short-selling stocks can be a lot like sports betting where traders take risks comparable to placing high-odds bets. Whether or not it is right for you is up to you, but if you enjoy having a little bet on a game here and there, betting on stocks could be even more fun for you. Just as successful sports betting requires skill, knowledge, and calculated risks, short selling demands careful analysis and risk management. Give it a try.