Short Sale
Candlefocus EditorThrough a short sale, a trader will never benefit from a stock’s rise in value; the only way to make money from a short sale is if the price of the stock falls. The trader is at the mercy of the market, however, and can easily experience heavy losses if the stock’s price rises instead and they are unable to buy it back before expiration.
A short sale is accompanied by significant risks, especially when it comes to timing. The key to success with a short sale is to accurately predict when to get out. This can be especially tricky if the stock’s value suddenly turns and the investor is unable to buy back the shares before the market’s close. The demand for borrowing certain stocks can also be a factor, so a trader should remain aware of the market’s liquidity at all times.
In addition to these risks, there is also regulatory risk. In the United States, the Securities and Exchange Commission (SEC) has introduced rules to govern these trades, including the so-called “uptick rule” that requires a short sale to be executed at a higher price than the previous trade. In other countries, the rules may vary. Demonstrating an understanding of the applicable regulations is important for making any short sale possible.
Because of its inherent risk, a short sale is a tool that should be used for speculative trades only. It is not suitable for beginner traders and should be avoided at all costs by those with limited exposure to the stock market.