3 Things You Need to Know About Short Selling

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

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Making a profit when a stock’s price drops may sound too good to be true, but the process is simpler than it sounds. All you need to do is sell high and buy back low. Short selling can be a powerful tool for your portfolio — from hedging risk to adding leverage to a bearish trade, the possibilities are almost endless.

The Process

In case you need a refresher on the short-selling process, let’s break it down into four simple steps.

1. Borrow the security you want to sell short from a broker.
2. Sell it at the market price. 
3. Buy it back at a later time when the security is trading at a lower price.
4. Return the borrowed security to the broker.

Keep in mind that this simple overview does not cover all the possible scenarios in which shorting might be used. While selling short is a versatile strategy there are a few things you should know before you use this strategy in your portfolio. 

1. It’s all About Location, Location, Location.

Borrowing shares involves locating them from a broker, which can sometimes prove harder than one may initially assume. Some stocks may be marked HTB (or hard to borrow) and may incur upfront “locate fees,” which are usually a flat fee per share. Sometimes shares of a certain stock may not have enough availability to borrow. 

Consequently, when you’re looking to make a short trade, ensure that your broker can locate the stock you are looking to borrow and note how much the broker will charge you to find those shares. Just like any other fees, locate fees can quickly eat into any profit you might make from a trade. 

2. Make Sure the Volume’s Turned Up.

As with any trade, timing can be key when choosing an entry and exit point. This is especially true with short selling because it has built-in leverage because you are borrowing the stock used in the trade.

If you were to short-sell a stock that had very thin or inconsistent volume, you may find that you are unable to exit your position at the desired price. This could lead to a larger loss than anticipated. So, always make sure that there is sufficient volume in the security you are looking to trade.

3. Stop on Red.

With the unlimited loss potential inherent in short selling, it’s important to mitigate this risk by having a clear exit strategy for your trade. This allows you to buy back the stock and cut your losses quickly. The easiest way to ensure you have a clear exit point is to set a buy-stop order for your short sale. A buy-stop order will be executed when a specific price has been reached and will buy the stock at the next available market price. Having one in place can help you avoid a devastating loss. 

As you venture into the world of short selling you may want to consider trading up when it comes to your broker. While big-box brokers may look attractive because of their low upfront fees, they often have hidden downsides and high fees for things like borrowing shares to short. A good solution to avoid these high fees may be a smaller more trading-centric brokerage such as Cobra Trading.

Cobra Trading is a boutique brokerage that focuses on one-to-one customer service and fees designed for active trading. It even has various options to help you locate those hard-to-borrow securities, which is one reason Cobra Trading won Benzinga’s award for the Best Broker for Shorting Above $25K. If you’re interested in a more customized trading experience, you may consider opening an account with Cobra Trading and see what it has to offer.

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.