What is a short position (or short position)
A short or short position is created when a trader first sells a security with the intention of buying it back or covering it later at a lower price. A trader may decide to short a security when he believes that the price of that security is likely to fall in the near future. There are two types of short positions: naked and covered. A short nude it’s when a trader sells a security without owning it.
However, this practice is illegal in the United States for stocks. A covered short occurs when a trader borrows the stock from a stock lending service; in return, the trader pays a borrowing rate for the duration of the short position.
In the futures or forex markets, short positions can be created at any time.
Key points to remember
- A short position refers to a trading technique in which an investor sells a security with the intention of buying it later.
- Short selling is a strategy used when an investor expects the price of a security to fall in the short term.
- In common practice, short sellers borrow shares from an investment bank or other financial institution, paying a fee to borrow the shares while the short position is in place.
Understanding Short Positions
When creating a short position, it should be understood that the trader has a finite potential to make a profit and an infinite potential for losses. This is because the profit potential is limited to the stock’s distance from zero. However, a stock could potentially rise for years, creating a series of higher highs. One of the most dangerous aspects of being short is the possibility of a short press.
A short squeeze occurs when a heavily shorted stock suddenly begins to rise in price as traders who are short begin to cover the stock. A famous short-squeeze occurred in October 2008 when Volkswagen shares surged as short sellers rushed to hedge their shares. During the short-squeeze, the stock went from around €200 to €1,000 in just over a month.
A concrete example
A trader thinks Amazon‘s stock is on the verge of falling after reporting its quarterly results. To take advantage of this possibility, the trader borrows 1,000 shares from its stock lending service with the intention of selling the stock short. The trader then goes out and sells short the 1,000 shares for $1,500. Over the next few weeks, the company reports weaker-than-expected revenue and forecasts a weaker-than-expected quarter ahead. As a result, the stock plunges to $1,300, the trader then buys to cover the short position. The trade results in a gain of $200 per share or $200,000.
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