Selling high and buying low is called ‘going short’ or ‘short selling’. It has become a powerful tool for traders looking to make a profit when the markets are down.
How can you actually use this?
Using this trading strategy, means that you aim to profit on the decline in price of a stock or share, in other words you sell high and buy low.
It is used when markets are falling, or alternatively as a hedging tool, benefiting in the decline in a share’s price using contract for difference (CFDs) rather than the actual shares.
What’s the real story?
In a nutshell, by using a CFD, you agree to the terms beforehand with your broker and at the end of the transaction settle the difference between yourselves without any changing hands of the underlying asset. It is one of the best ways to make a profit when the markets are down.
You profit from a fall in price and enjoy leverage which typically is 10:1, meaning that you control ten times as many shares than you would have been able to afford with your initial investment.
We can’t emphasize enough…
Understandably for a lot of people, it takes maybe a little bit out getting your head around the idea of how short selling work.
Traditionally, if you come from an investment background, when we see a market that’s going up and it gets to a point where you think that it may have gone far enough, you’re going to sell and take your profits.
Normally, you do something like this and that is very similar to short selling.
If you have a market that’s sliding and you believe that it’s going to slide further then the most logical move is not to place a Buy because what’s the point of buying if the market is just going to get cheaper, right?
If the market is sliding lower, with short selling what you need to do when you open the trade is that you sell first.
Now this is the concept that has some people in the beginning may be tying their brain in knots – the idea of selling something you don’t own with a view to buying it back later on.
But it’s exactly what short selling is. Let’s say you’ve placed a Sell position and as the market moves lower and lower, you place a But when you think that the market has gone far enough.
It’s important to understand these things first before you go on and place a trade.
Remember: If you’re buying, the profit is the difference between your buy price and where you sell.
If you’re short selling, it’s basically the same sort of process where you opened the trade by selling first and where you closed the trade. That determines your profit or loss.
If the markets are sliding, you can profit for them by using short selling. And with short selling, whilst on the face of it, it might look a little bit complicated but it’s really the same as buying and selling only that the process is reversed.
How can you actually use this?
It is a 3 step process:
• Borrow shares of the company that you wish to short from your broker.
• Sell the shares on the stock market at the market price.
• Re-buy the shares (at a lower price hopefully) and return them to the broker.
The difference between what you bought them and returned them to your broker goes in your pocket.
Here’s how it works
To open a trade on their platform switch the toggle from ‘buy’ to ‘sell’ which will open your trade (this position means you are going ‘short’). As the asset’s price goes down, the value of the asset will increase.
Now, you need to make sure that you check the ‘buy’ price because on the trading platform prices on eToro have a spread, the ‘buy’ and ‘sell’ prices are different, with the ‘buy’ prices always higher.
So, when you close your short position the ‘buy’ price is the price you get when you close. (You should note that this is the most desirable scenario for you, it could prove to be less favorable).
Let’s take a look at eToro’s trading platform and we’ll place a trade designed to profit if the market falls.
So here’s our eToro gold CFD chart and we’ve seen something of a strong run in the price of this instrument in recent weeks as the world has become maybe a little bit nervous and a little bit uncertain and the US dollar has weaken.
But let’s say you’re of the opinion in the short term that the price of this instrument has gone too far now and you’re going to take the view that its price is due to fall from here.
Now that you’ve taken the view that the instrument’s value is going to drop, that means you’re not going to buy but rather click on Sell.
Once that’s done and the trade opens, that’s it. You’ve short on gold. You’re now positioned to make a profit if the price drops from where you opened the position.
And just like other trades, you can place a stop loss or a take profit order.
Using short selling as a trading strategy is a powerful tool and opens a variety of new possibilities where you can profit when the markets are down. In addition, it can also be used as a hedging tool to protect yourself if a position backfires.
That’s our very basic explanation of how short-selling works. This demonstrates that it’s as easy to try a profit from markets that are sliding as it as it is trying to profit for markets that are rising and you do that via short selling.
It makes a lot more sense when you actually do it yourself. If you’ve never done it before, just try it out using a demo account.
The best way is to do it small and not take on ridiculous levels of risk. Start by doing a small trade selling something short so you can get a feel for how these things work.
Another quick and simple way is, you can experiment using eToro’s free unlimited demo account that comes with virtual money. Here you can explore all options and hone you’re trading skills before trading with your own money.
eToro offers a comprehensive and in-depth education, with ebooks, webinars and more. Here, you have a wealth of information that will provide you with strategies for short selling.