Investors that regularly and successfully sell short are knowledgeable and experienced traders. A novice investor can learn how to successfully sell short, but should not start there. A shorting strategy should only be used by experienced and sophisticated investors.
Knowing shorting basics helps new investors better understand stock market action. Just don’t actually short a stock until you have considerable knowledge and investing experience.
Educate yourself by building your base of knowledge and establish an successful investing record first. Then you can consider adding selling short to your investing toolkit.
Part 3, White Top View series Short Story on Short Selling
In Part 1, Novice investor asks, “Explain selling stock short”, we opened our discussion of selling short.
In Part 2, Investor, is a stranger selling your stock? we continued by explaining as short sellers must borrow stock, they could be selling stock that you own!
Today in Part 3, we continue our discussion to include other things a short seller must consider before using this investing or trading strategy.
Sophistication of shorts
Besides knowledge and experience, traders that regularly and successfully short have other characteristics. As a group short sellers tend to be confident, sophisticated investors with excellent research skills. They do their homework and their own thinking.
They are also thick skinned and indifferent to the howls of protest and name calling that come with selling short. Overtly and publicly selling short is an investment play against a specific company. At times such a bold move can attract lots of attention.
Sometimes the name calling includes suggestions that selling short is anti-capitalist. Short sellers scoff at that and see themselves as pro-market players that add trading liquidity.
Anyone that does not agree with them, meets a ‘get over it’ indifference. Successful short sellers know the rules and accept the risks of being short.
The successful short, when played well, produces very significant profit in a relatively short time. Once a known short seller develops a track record and following they can become very formidable opponents.
Short targets need careful selection
Short traders seek stocks that can significantly fall in price. The short sale takes place when the trader knows, believes or speculates that the fall in stock price will begin soon.
The traders acquire or research information that makes them believe the price of the shares will fall. Stock prices can fall for many reasons.
Facts or rumors can affect or influence the stock market, broader economy, a specific industry, or the company itself. Successful large shorts are based on fact although rumors alone can create short selling opportunities.
Successfully picking and executing a profitable short trade takes considerable knowledge and skill. This is no place for a beginner to dabble.
Larger companies attract more shorts
The requirement to borrow stock puts a practical low end limit on the size of a company to short. If you can’t borrow stock, you can’t sell short. So typically only the more widely traded, large companies attract short sells.
That does not apply universally. As long as you have a cooperating stockbroker, with an inventory of shares to loan, you can short. At times that can mean even a small or micro cap stock may make a good short.
However that is unusual. In fact the market rules prohibit penny stocks, those under $1.00, from being shorted. Additionally the stockbroker can actively discourage shorting by refusing to loan the required stock.
So practically speaking, only medium and larger sized companies get shorted. In addition, the short target must also trade a certain volume of shares. Thinly, infrequently traded or shares of companies that only trade in low volumes do not make good shorts.
In such cases there are not enough buyers for a short seller to establish a significant position. In such cases, that low volume effectively protects the company from any significant short selling.
Nine things short sellers must know will be the topic in our next White Top View discussion.
Do you know anyone who sells stock short?
These bite sized lessons are intended to demystify investing. You can become a knowledgeable confident investor, one small step at a time. Please ask questions, I can help you better understand markets and investing. The White Top Views email list will not be shared or sold.
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White Top Investor
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Links to all parts of the White Top View series, the Short Story on Short Selling, follow below:
Part 8, Short selling has rules
Part 10, Four more positives of short selling
Part 12, Shorting stocks is hard