Click here to Login

Short Selling Stocks

Updated on 2010-01-12

If you think or forecast that a stock will lose value in the future, you can borrow this stock in exchange of an interest you will have to pay (this interest depends on the period you hold this stock). You can then sell this borrowed asset and earn money if it decreases in value. When the lender wants its stock back, you can buy the same stock in the market and then give it back to the lender.

Let us say you sold the stock at 20$; for the sake of simplicity we will not account for the interest you will have to pay. After the holding period, when you return back the stock to the lender, if the stock decreases in price and is valued at 10$. This means that you bought it back at 10$ and thus earned 10$. However, if the stock increases in price and is valued at 30$. This means that you bought it back at 30$ and thus lost 10$.

This process is what is called a short sale in trading. Short selling offers traders a means to profit from a declining market, overpriced stocks...
As you just saw, the mechanics of a short transaction (selling stocks that you do not own) is much more complex than the mechanics of a buy transaction. Fortunately, your broker will handle all of this for you. The broker will borrow stocks for you; he will give them back to the lender when you want to cover your position. He will also calculate and tell you exactly how much interest you need to pay for borrowing that security. However, you will need to have a margin account to take part in any kind of short selling. These kinds of brokerage accounts will have minimal capital requirements.

When using this trading software to developed trading strategies, you can create long or/and short trading systems. Instead of the traditional process of buying and selling securities, short trading systems allow you to short sell stocks, which means that instead of buying stocks, the trading system will short stocks and instead of selling stocks, the trading system will cover stocks. When you create a trading system with the simulator tool (Analysis -> Simulator -> New), you can select the type of system you want to create. Near "System Type", you can choose between three options: Long, Short or Long/Short. Below that button, you can specify the rules for your short selling stocks strategy in the Short and Cover boxes.

When analyzing trading rules using the rules analyzer tool (Analysis -> Rules Manager -> Analyze), you can specify one or several outputs/exit rules. If you select for example the "use N-Bars stop" and change the "Type" from "Buy" to "Short", you will end up with an exit rule of type "Short then cover after x bars".

Finally, I would like to point out the fact that short selling stocks is a riskier trading activity. In fact, the maximum loss of buying stocks is limited to the invested amount, while the potential loss of short selling stocks is unlimited. This is because there is no limit to how high a stock or security can go. For example, a stock may experience a high earning surprise that could increase its price by more than 100%. The unlucky trader who short sold this stock may, in this situation, loose much more than the money he invested.

Trading objects that may interest you:
NYSE Arca - Daily short sale data
NASDAQ and Boston stock exchanges - Daily short sale data
Short Selling historical data
NSX - Daily short selling data
Short Selling Data

no comments (Log in)

QuantShare Blog
Search Posts

Recent Posts

Create Graphs using the Grid Tool
Posted 1291 days ago

Profile Graphs
Posted 1396 days ago

Previous Posts

Short Selling Stocks
Posted 5269 days ago

Stock split & dividend
Posted 5275 days ago

Survivorship bias
Posted 5282 days ago

Transaction Costs
Posted 5290 days ago

How to simulate options strategies
Posted 5304 days ago

Organizing Trading Objects
Posted 5311 days ago

How to search for a download item
Posted 5325 days ago

Trading orders - Part 2
Posted 5332 days ago

Trading Orders - Part 1
Posted 5339 days ago

More Posts


Create an account
Affiliate Program
Contact Us
Trading Forum
How-to Lessons
About Us
Terms of Use

Copyright 2024
Social Media
Follow us on Facebook
Twitter Follow us on Twitter
Follow us on Google+
RSS Trading Items

Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.