What is selling short? Discover what are bearish investments in the stock market
What happened to investors through Reddit has once again focused attention on a financial operation that is not suitable for risk-averse investors short interest. What do short positions mean? We are going to explain in a simple way this way of investing that is being talked about so much and that colloquially is also said to “go short in a security ”.
What are short positions or going short?
Going short or short means betting/investing on a security falling . In the stock market, it is normal for an investor to invest in a stock thinking that it is going to rise (bullish or long position).
However , there are ways to invest that also allow you to bet on the fall of a value, currency or index. This form of investing is called going short, going short a security, or investing down. It is used, in addition to investing downwards, to protect an investment when they see too much volatility or simply want to reduce risks because it is a more or less important investment. That is, you can be investing for a rise, but at the same time protect yourself in case it falls.
How does investing to the downside work?
Through a bank or broker that allows this operation, you sell an asset that you do not have in your portfolio – you buy them on credit from a broker – with the idea that the price will go down, that you will buy them in the future. to a lower level and return them (close the position) . It should also be known that these types of operations are usually carried out in the short term or for a short period of time, especially between individuals. In fact, many trade this way intraday.
Explained step by step:
- Securities are borrowed from a company, which will have to be returned in the future (the time period is agreed).
- The shares are sold in the market as if they were securities that the investor has in his portfolio.
- When the shares fall on the stock market, they are bought again to then return those shares to the entity or investor that lent them. This is called a credit sale. The difference between the sale and the purchase is the profit (the profit will increase the greater the decrease in the price of the security). If at that time, instead of going down, the shares go up, you have to buy them more expensive and you also have to return them to their owner with a loss.
For example, you buy shares of a company on credit that are trading at 5 euros, thinking that they will drop to 3 euros/share. In this case, the investor would earn the difference between the price at which he sold the assets and the price he paid to buy them later (2 euros of profit per share).
What does it mean to close positions on the stock market?
Closing a position on the stock market means carrying out a transaction opposite to another that has already been carried out in the past on the same financial asset . If the investor bought a stock, for example, to close it he will have to sell it.
Where do the shares come from to invest in the short?
They come from other shareholders who have shares in a more or less stable manner and who allow the banks where they are deposited to lend them (as if it were a “rental”). In exchange they receive an interest rate from the bank .
That is, summarizing everything we have:
- Shareholders who lend their shares to the bank or broker in exchange for an interest rate.
- An entity that has these titles deposited and allows other clients to operate with them at a lower price if they think that their price on the stock market will fall.
- Some investors who operate in this way.
Risks of short trading
The investor is obliged to return the shares and close the position. Thus, if the strategy fails and the price rises, the investor will have to repurchase the most expensive securities in the market to return them to the lender, with the consequent loss, which will depend on the volume of the rise.
Investing short as a hedge
This type of investment is also used as a hedging mechanism for a long or bullish position . Therefore, they serve to protect another investment. As? The investor takes a short position to hedge the risk that his bullish bet will fail. It allows you to offset the fall in the stock in which you have invested with the capital gain generated from the sale of your short position. In this case, the operation is not so much speculative, but is designed to minimize the risk of the investment.
What kind of investors do it?
This type of investment is a common practice for hedge funds, alternative management funds or high-risk investors . They can invest in any type of financial asset, follow the investment strategy they consider most appropriate and sometimes even combine it with a credit operation that allows them to borrow four or five times the value of their assets and multiply their investment.
The big ones have powerful vehicles to play against the prices of shares, currencies or raw materials. They are not always well regarded by minority investors – they are generally labeled as speculators – but there are those who argue that bears provide liquidity to the system since if there are bearish investors, there will be more people who can buy and sell shares.
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