How to short a stock

When shorting a stock via a traditional broker​​, traders borrow shares they do not own. These shares are usually lent from their financial broker. The trader then sells the borrowed shares at market value. The trader aims to repurchase the same shares at a lower price and return the shares to the lender. If the price of the stock drops, short-sellers profit from the difference in price between the rate they borrowed at, and the rate they repurchased the shares.

This method does come with some caveats, but namely that it is up to the broker to decide if the share can be shorted. However, say that you can find a broker to lend you a stock to short, you will most likely have to pay borrowing fees as well as any dividends paid by the borrowed stock. Given the costs and the complexity of short selling, it is often recommended for experienced traders. There is, however, a more accessible way to short sell stocks known as leveraged trading.

When traders short sell via leveraged trading, they do not own the underlying stocks. CFD trading​ is a type of leveraged trading and offers the trader an opportunity to take a ‘sell’ position on shares and profit from stock price downfalls without the need to borrow physical stocks. With leveraged trading, your profits and losses are magnified by your leverage ratio.

Technical analysts could short a stock based upon what direction the general trend is heading. Using simple trend line indicators, technical analysts would analyse the trend direction of a share or stock. If the trend showed no signs of slowing down, it would present a key opportunity for technical analysts to ride the trend downwards.

Technical indicators such as the simple moving average (SMA) or exponential moving average (EMA) can provide key insight for technical analysts. Stocks that drop through prominent support points or fall below major moving averages (e.g. 200-day moving average) may continue on a descending trend.

Missed earning reports present a big opportunity for short-sellers. If a company profit does not meet profit estimations, it is likely to be underperforming in certain areas. This could cause a large number of investors to start short selling. However, it is often best to look beyond just earning reports, as a company may be underperforming for reasons that do not impact its stock price.

Declining industries provide another opportunity for short-sellers. Industries that have experienced a general downtrend due to innovations in other markets or negative client sentiment can cause a particular stock’s price to plummet. This can also be affected by political and economic events such as presidential elections and trade wars. When an industry is perceived as obsolete, companies in that competitive space can be left with dwindling growth prospects, causing short sellers to take advantage.

Overvaluation is a common factor that can cause short sellers to come together. Stocks that are constantly covered in the news can cause the price to hyper-inflate relative to the stocks actual value. Once the stock market bubble​ bursts, short sellers will come together knowing that the stock is not worth its current market value.

However, please note that a stock’s fundamental values are not sole determinants of its price. There are various factors to consider when shorting a stock, and these factors form a complex picture. Each trader should do their own research when considering to trade stocks.

If Apple’s value then falls to $250, your position would now be worth $2,500. You could then close out and net a $500 profit.

If your instinct was wrong and the Apple’s value instead climbs to $330, your position would then be worth $3300. This would mean a $300 loss for you.

Jim Chanos is a legendary (or notorious, depending on your perspective) short seller who was one of the first to pick up on the trouble brewing at US energy giant Enron. When the wheels came off the company and everyone released its senior management had been cooking the books, its share price collapsed and Chanos’ firm Kynikos picked up a $500m profit.

As documented in The Big Short, a number of investors saw the trouble on the way in the US housing market and wisely bet on the failure of mortgage bonds via credit default swaps and walked away with massive profits.