Most people assume day trading is buying a stock at a low price and selling it at a high price. It may be that, roughly, 90% of traders buy long. This is just a more commonly known way to trade on the market.
However, you can also make a profit by placing a bet against the stock. All you need to do is sell the shares high and buy them back low. That is called short selling. Basically, you are betting the current price of the stock will go down. Short selling makes sense when a stock has negative news or any other kind of negative catalysts.
Selling short vs. Buying Long
It’s important for you to know that short trading implies higher risk. When you take a negative position, you could lose more than you own. Let me clarify that statement by giving you an example.
When you want to buy a stock and go long, you can only buy as much as your capital allows. And if the trade goes down against you, making the worst-case scenario happen, the maximum amount that you can lose is 100% of your investment. To be clear, if you trade using a margin loan, a 100% loss could be more than the cash you have in the account. Nevertheless, if you buy 100 shares at $1/share and the price goes down to 0, you lose the entire $100.
But when you’re selling short, you are borrowing the shares that you’re trading from your broker. Let’s say you started with 100 shares at $1/share, and the price went up dramatically, hitting the $5 mark. When you took your position, you borrowed the shares, investing $100. But once the stock price hit $5/share, your total investment became $500 since you still have to buy the shares that you’ve already sold at $1/share. This way, you have just lost $400 on your initial investment of $100.
This may sound unrealistic to you right now, but we’ve recently seen stocks go up 1400% and more within one day. As you can see, you can lose your money very quickly when short selling. To avoid that, you want to have your trading plan in place. More specifically, you need to have an exit strategy. If you don’t know when to exit safely when a trade gets out of hand, you can effectively lose your account in a matter of minutes. At Cobra Trading, we want to make sure that you’re prepared for all situations in advance. We want you to know what you’re getting yourself into and feel confident when trading.
HTB and Borrows
Another thing that isn’t discussed often enough in relation to short selling is borrows. When you’re trading, some stocks are marked HTB – hard to borrow. What does that mean?
Before you enter the trade on the short side, you need to borrow shares from your broker. If the stock is HTB, you’ll need to request those shares and you may have to agree to an upfront locate fee, typically a flat amount per share. Now, every broker is different. When you’re trading with Cobra, you may be able to locate the shares directly through your platform and also have access to us using a one-on-one chat. We are often capable of giving you these borrowed shares at no additional cost. We do it because we strive to provide the highest level of customer service. And if we can’t get you those shares without the upfront cost, we’ll make sure to try and get them at the lowest price possible.
Bulls and Bears: Which One Are You?
So this is a brief introduction to short selling, otherwise jokingly named trading on the dark side. It’s exactly the opposite of traditional trading when you buy low and sell high. Instead, you sell high and then buy low.
Alternatively, you might have heard people talk about bulls and bears. Bulls are long buyers and bears are short sellers. If you want to be called a bear and you’re willing to go against the grain while betting against the 90% of other traders, selling short may be for you.