Understand The Shorting Stock
For a long time speculators, individual investors, hedge funds, arbitrageurs, and gamblers have been using the technique of shorting the stock. They were willing to take potential risk of incurring a capital loss. It is also known as short selling which involves the selling of stocks which the sellers actually do not own. The trader also sells other kinds of securities short including the options.
Why traders sell short?
The sellers take up these transactions in hope that price of the stock will go downward in future and if they are able to sell those stocks today, the traders will buy back those shares in future. If at all they are able to achieve this, they can make profits in the difference between sale prices and buy price. Few of the traders conduct short selling purely for the purpose of speculation and while some others might want to protect or hedge their downward risk when they hold long positions.
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Risks you need to be careful of
When you short the stock, you would expose yourself to substantial huge financial risk. Whenever the traders and investors find that the stock has a huge short interest which means that the high percentage of shares available are shorted by the speculators then they try to drive up the price of the stock. This will force the speculators to buy back those shares which have been sold earlier before the prices go up too high.
Whenever you sell the stock short, you should assume that all the time you will be able to buy it back at the amount you want. The market for those particular stocks should be there. If in the market, no one is willing to sell those stocks or there are so many buyers in the market who had panicked and they try to close their positions before they lose the money, you will end up in incurring huge loss.
You need to understand that the market is quite volatile and should never assume that the price of the stock will change according to your assumption. Hence, the short selling is used by only the seasoned traders who understand and know the risk. There are rules to be followed while you short the stock and it has to be followed religiously.