It refer to a trading practice in which sellers sells a security with an objective of repurchasing it at lower market price. This technique is used when a financier expect the price of security will decrease in short term. Going short is most advance trading technique which only be started by experienced investors and traders. Portfolio managers or investors may use going short as a hedge against downside risk while traders use it as speculation. Speculation is an advance method that carries the chance of considerable risk while hedging is more common position to diminish risk exposure.
In going short, position is opened by the investor through borrowed share of stock with a hope that it will decrease in value near future date. The investors then sells share of stock to buyers eager to pay current market price. Before returning borrowed share of stock, trader is biting the value will continue to drop and they can repurchase it at lower price. The risk of going short is theoretically is limitless since after selling, price of any stock or asset can climb to immensity.
In order to open short position, traders must have margin account because you will have to pay interest on worth of borrowed share of stock while position is opened in market. Federal Reserve and New York Stock exchange have set least values for the volume that the margin account must uphold, known as maintenance margin. The Financial Industry Regulatory Authority Inc. applies the guidelines and regulations governing registered brokers and broker dealer firms in the United State. If trader’s accounts worth falls lower the maintenance margin, additional funds are required or position might be sold by the broker.
Going short involves infinite level of risk if seller’s guesses erroneous about market movement. A trader who has bought share of stock can only lose 100% of their amount if the stock moves to zero. Going short have some pros and cons, let’s have a look at them.
Pros:
- Slight opening capital is required
- Opportunity of high profit
- Hedge against other holdings
- Leveraged investments possible
Cons:
- Margin account requirement
- High risk involves
- Margin interest suffered
- Short crushes