There are so many different terms and strategies to understand when you are building a stock investment, that it is easy to see why so many people are worried about investing. With terms like shorting stock and day trading to consider, it’s almost like you need to learn a new language before you can start building your portfolio. If you’ve been looking into the concept of short selling stocks to make a quick profit, you’re in the right place. We’re going to explore an introduction of how stock shorting actually works, and address what happens when a short squeeze occurs too. Let’s get started.
What is Shorting Stock?
When you are short selling stocks, this means that you sell a security with the belief that the price will drop going forward. This means that you can re-buy the shares that you want to purchase later at a much lower price compared to what you originally paid. The benefit is that you get to make money on the difference between the initial cost, and the final payment you obtain.
While this can be a valuable way to make money if you run hedge funds, or want to diversify your current investment portfolio, there are also many issues you need to be aware of. For instance, there’s never a guarantee that the stock you sell won’t increase in price rather than falling. This could mean you need to spend more money getting your assets back. Many investors need to take their time considering the pros and cons of this strategy. While you can speculate on the decline of various securities and make a lot of money, there’s also the risk that you could lose an infinite amount of cash because the price of your security could raise an endless amount.
What about the Short Squeeze?
One of the biggest concerns of the shorting environment for many investors is the potential to short squeeze stocks. This basically refers to an instance where a stock or another asset jumps higher in price very quickly, often without warning. This pushes the traders who otherwise bet that the price would fall to buy it fast and avoid potential greater losses at a later stage. The sudden scramble to buy places further pressure on the price of the security.
The short squeeze can be a very stressful experience for any individual investor or hedge fund manager. Short sellers make their money on the idea that a certain security is going to drop in price. If the opposite happens, they need to buy the stocks as quickly as possible or they could lose even more cash. The more people panic, the more the costs go up. This happened in the year 2019, with the Tesla stock increased by 400%, and short sellers lost around $8 billion.
Short squeezes often happen when something suddenly changes the demand or feeling towards a certain business. If something significant happens, like a sudden change in customer trends, or the business releases some information that changes it’s standing in the stock market, the entire attitude to that company and its securities can change almost overnight.