Trading online: What is a Short Position?

In today’s world, trading online has become a more and more convenient option for buying and selling financial products on trading platforms provided by brokers and is available to everyone who wants to benefit from the stock market. One of the online trading techniques is short trading, in which an investor sells a security with plans to buy it later. Let’s break the ice and understand what is a short position and how you can utilize it in online trading.

Understanding Short Positions in Online Trading: Borrowing Stocks to Anticipate Price Decline

A short position is a strategy investors use to anticipate a rapid decline in the price of a security. In simple terms, short sellers borrow stock shares from a financial institution and pay a fee while maintaining the short position.

There are generally two types of short positions – naked and covered. A naked short refers to selling a security without actually owning it. However, it’s important to note that this practice is illegal in the UK and the US due to its potential impact on equities.

On the other hand, covered positions involve borrowing shares from a stock loan department and paying a borrowing rate throughout the duration of the short position.

Short Positions: Balancing Profit Potential and Risk

Creating a short position carries the potential to earn a finite profit but also exposes the investor to infinite potential losses. This is because the profit potential is limited by the distance the stock can fall, while there is always a chance that the stock could rise significantly over time.

Furthermore, the maximum profit that can be achieved from a short position is equal to the stock price. For example, if the stock price falls to zero, the maximum gain would equal the price it was shorted.

Setting Up a Short Position in Online Trading: A Step-by-Step Guide

You will need a brokerage account and a margin account to set up a short position, as margin and interest are involved in short trading. 

  1. Log into your trading account, whether it’s a brokerage account or trading software.
  2. Select the ticker symbol of the stock you want to bet against.
  3. Enter a regular sell order to initiate the short position. Your broker will likely automatically locate the shares to borrow.
  4. Monitor the stock price and place a buy order when the price decreases.
  5. Once you repurchase the stock, return it to the lender and close the short position.

Note that not all shares can be sold short,  as the availability of shares to borrow primarily depends on your broker’s ability to find shares for you to borrow at the time.

Understanding the Risks of Short Positions: The Dangers of a Short Squeeze

Although short trading can be profitable, it also carries certain risks. One of the most dangerous risks is the possibility of a short squeeze. It happens when the price of a shorted stock begins to rise, causing short traders to buy back shares at significantly higher prices than what they originally sold them for to cover their positions. It often leads to significant losses.

That is why it is essential to thoroughly understand the risks and rewards associated with short positions and the necessary steps to set up a short position. With proper knowledge and strategy, individuals can navigate the world of online trading and make informed decisions to achieve their desired outcomes.