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Short Selling 101

Short selling is betting against a stock. Instead of buying a stock and hoping the price goes up, traders borrow the stock from a brokerage and sell it right away at market price. Eventually, the trader must buy the stock back from the market to return it to the brokerage, so if the price drops, they can do this at a profit, but if it rises, the trader makes a loss.

This is an advanced strategy, which is why it isn’t as common as “going long” or buying and holding a stock. If used diligently, short selling can be an important tool in a sophisticated investor’s arsenal.

Here’s how you can get started with short selling on tastytrade.

1. Getting started

Because you need to borrow shares as the first step to short, you must first establish a margin account. This is why the margin rate, or your cost to borrow, is an essential element in making your choice for the best brokerage.

tastytrade’s competitive margin rates, ranging from 8% to 11%, make it an ideal platform for investors looking to deploy complex strategies like short selling.

2. Finding targets

The next step is to find ideal short selling targets. Traders generally use one of three strategies to identify short selling targets: fundamental, technical or thematic.

A fundamental trader would look at underlying earnings to see if the stock price is too inflated, while a technical trader could use charts and patterns to see if the stock price is due for a correction. A thematic investor, meanwhile, focuses on industry themes, such as economic factors or new technologies impacting specific sectors.

Regardless of your strategy, your ultimate goal is to find a stock that’s likely to lose value.

3. Formulating strategies

Identifying a stock that’s likely to lose value is only part of the battle. To make money from short selling, you also need to factor in other variables such as time, float and costs.

On tastytrade, short sellers can quickly look up variables such as total float and hard-to-borrow fees to understand the costs involved in each trade.

Meanwhile, other features could help you set guardrails for your trading journey.  “For instance, traders can set price alerts and manage risk using stop orders,” says Chiou.

Traders also have access to a Hard To Borrow indicator, which indicates when a stock becomes subject to an HTB fee and is expensive to borrow.

4. Lowering costs

Short sellers work with chaos. Many of the factors we’ve discussed in this guide - from liquidity to stock price - are beyond your control. This is why it’s so important to maximize your grip on the few factors you can control, such as cost.

Picking a low-cost trading platform can help you keep more of your profits if your strategies are successful. tastytrade’s commissions are $0 for stock trading and capped at $10.00 per leg for equity and ETF options, which makes it the perfect fit for pragmatic options traders.

5. Lowering hidden costs

Margin interests and dividends are costs that most short traders are well aware of. However, there are some costs that even experienced traders fail to account for, such as the hard-to-borrow fee.

Chiou believes HTB fees add risk and lowers potential profits for short traders.

tastytrade offers traders plenty of transparency and visibility regarding these hidden costs. The Hard-to-Borrow indicator built into the platform and a detailed list of all the commissions and fees involved in every trade allow traders to take the total cost into account before placing the order.

6. Understanding taxes

Taxes on short selling could get complicated for most traders. You may need to consider if your gains are short-term or long-term, whether the interest on your borrowings is tax deductible and other factors.

You’ll need an accountant to untangle this web, but your accountant will need a comprehensive overview of all your trades and relevant documentation. Traders on tastytrade can access all these crucial documents from the Tax Center to ensure they minimize taxes as efficiently as possible.

7. Other strategies

Betting against a stock is the most common and typical strategy, but that’s just the tip of the iceberg. You could also bet against a whole sector or exchange-traded fund if you’re bearish on a wide group of companies.

You could short an index fund – such as the S&P 500 – if you believe the whole stock market is due for a correction (though you do so at your own peril). You can also find opportunities to use protective puts in combination with short stock for potential accelerated gain in a downward market or protect your assets such as long stock or even covered calls.

Features such as the Analysis Tab and Liquidity Rating Indicator could assist you if you use put options instead of shorting directly.

All investments involve risk of loss. Please carefully consider the risks associated with your investments and if such trading is suitable for you before deciding to trade certain products or strategies. You are solely responsible for making your investment and trading decisions and for evaluating the risks associated with your investments.

Trading in a margin account is not suitable for all investors. It is important that investors understand the risks involved in trading securities on margin prior to investing in a margin account.

Options involve risk and are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially significant losses. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

tastytrade, Inc. is a registered broker-dealer and member of FINRA, NFA, and SIPC.

Vishesh Raisinghani Freelance Writer

Vishesh Raisinghani is a freelance contributor at MoneyWise. He has been writing about financial markets and economics since 2014 - having covered family offices, private equity, real estate, cryptocurrencies, and tech stocks over that period. His work has appeared in Seeking Alpha, Motley Fool Canada, Motley Fool UK, Mergers & Acquisitions, National Post, Financial Post, and Yahoo Canada.

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