Active traders do not have to wait for prices to rise on the stock market. By selling short, you can also profit from falling prices! We explain how to successfully plan and execute a short sale of shares and other assets, why this method is so important for your returns and what you should look out for.
The most important in a nutshell
- In a short sale, traders borrow an asset from their broker and sell it. If the price falls, they can buy the asset cheaply and return it to the broker. The difference represents a profit
- Short selling is easily possible with high-quality brokers and hardly causes any additional work
- As with all stock market activities, there is a fundamental risk of loss
- Options, futures and other tools also make it possible to profit from falling prices
Short selling: How short selling shares and co. works.
On the stock exchange Bull and bear The prices of shares and other securities rise and fall. The typical private investor profits with his Equity portfolio only from upward trends. However, downward movements are not uncommon and generate losses.
But we don't have to simply accept these setbacks! Active traders can also benefit from falling prices. They usually use short selling, a concept that is as simple as it is ingenious, through which falling stock market prices ensure rising income.
It works like this:
- Traders agree with their broker to borrow shares or other assets and return them later.
- Once you have received the agreed holdings, you sell them immediately - an “empty sale”, because the securities do not actually belong to you, but to your broker.
- The retailers can keep the sales price for themselves.
- At the agreed time, the asset is repurchased on the stock exchange and returned to the broker.
- If the price has fallen in the meantime, the retailer makes a profit from the price difference
Incidentally, the first short sale is attributed to the Dutch trader Isaac Le Maire. He invested his money in the shares of the Dutch East India Company in the 17th century.
When the company stopped paying a dividend, he recognized the downward trend. He sold his shares, but borrowed additional securities. Le Maire made a lot of money with the first short sell in history.
A lot has happened on the financial markets since then: you can now open short positions in all asset classes and are no longer restricted to securities. For example Futures, Options, ETFs, Fund and Currencies available.
When is the short sale used?
Short selling allows us to profit when prices fall. If prices rise, on the other hand, we take a simple “long position” (buying the asset and selling it later at a higher price).
Only in neutral phases, in which there are neither upward nor downward trends, is no profit possible. However, at such times we can Trade options, in order to still generate income.
This means that retailers have the right “tools” for every situation:
| Market phase | Tool |
| Upward trend / bull market | Long position (purchase of assets) |
| Neutral / sideways market | Options and other derivatives |
| Downward trend / bear market | Short sale |
So what is stopping us from accumulating huge profits in a very short space of time? We have to take the right position at the right time. And that's no easy task!
Market participants use a wide variety of techniques to predict price movements:
And many more!
- With the Chart analysis traders try to derive optical patterns from the prices
- Social Trading is an attempt to bundle the opinions of different traders
- At Newstrading analyzing the latest news to estimate price changes
- Forex signals are special key figures that are intended to predict the development of foreign currencies
- At Volume Trading the trading volume is specifically scrutinized in order to assess market interest
- Trading signals is information that is intended to help us with forecasting. For example, we can obtain it from service providers such as TraderFox refer to
- With the Sentiment analysis The aim is to identify the moods and emotions of market participants in order to subsequently place lucrative trades
Unfortunately, none of these methods is completely accurate. Forecasting always remains a risky endeavor that can lead to costly failures. So the problem is not to profit from falling prices - short selling is quick and easy - but to get the timing right!
Short selling example: This is what short selling shares could look like
Although in principle all assets are eligible for short selling, the short selling of shares is particularly well-known and frequently used. We would therefore like to show a practical example from this area for a better understanding:
- In our example, we expect the price of Amazon shares to fall sharply over the next few days due to poor business figures.
- We use our CapTrader account to complete a short sale on Amazon (if you don't have a matching account, you can Open a custody account online)
- In our example, Amazon is at 210 $ and we open a short sale for 50 shares. We therefore need to borrow 10,500 $ (210 $ x 50) via our broker.
- In the background, our broker immediately sells the securities for us on the stock exchange for 210 $ per unit.
- We now see a short position in our portfolio, value: 10,500 $.
- After one week, the price of Amazon shares has fallen to 180 $.
- We are now liquidating our short sale (“closing out” in stock market parlance): The securities are purchased on the stock exchange for 180 $ and returned to our broker.
- We made 30 $ x 50, for a total profit of 1,500 $.
The costs for borrowing are not included: they depend on supply and demand (number of traders in long and short positions). Transaction costs are also included, but are so low with CapTrader that we can ignore them at this point.
Prerequisites and start
Short selling is somewhat more complex than entering into a long position, as not every asset and not every broker is suitable for this. You should meet the following requirements:
- Broker selection: Only professional brokers such as CapTrader offer the option of short selling. If you do not yet have an account with a suitable provider, the first step is to open one. Open an account.
- Margin account: Borrowing assets, as is the case with short selling, is not possible without further ado. Your broker must check your personal and financial suitability. A so-called Margin account is required for this. It gives you access to short selling and other "professional tools" of the financial world.
- Suitable asset: Not all shares and other assets are suitable for short selling. For example, some assets are not available due to insufficient liquidity. To increase your choice, you should use a large, international broker such as CapTrader.
Theoretically, all assets are available as short positions, provided there are no regulatory restrictions.
- BaFin, for example, imposes certain requirements for shorting and prohibits, for example, the uncovered short sale of shares. However, this procedure is still legal in the USA.
- Further restrictions by the financial supervisory authority BaFin are possible in individual cases. For example, the authority banned short selling for two months during the inglorious Wirecard affair - as a result, the share price rose.
- During the 2008 financial crisis, BaFin banned short selling of bank shares. Such interventions by the state are very rare, but not completely impossible.
Apart from such prohibitions and requirements, shorting also depends on the availability of the assets: For example, in order to sell shares short, there must be traders who wish to hold and lend their securities.
This is because supply and demand also govern shorting. If there are not enough traders who want to take/hold a long position, the prices for short selling rise accordingly. It can then be uneconomical to open such a position anyway.
If the effort and risk involved in a short sale is too great, derivatives such as warrants or certificates can be considered for short positions.
What the difference Options vs. warrants we have examined separately for you.
Risk control for short selling
Short-selling has a dubious reputation among laypeople. This is due to events such as the wild Rollercoaster ride for Gamestop shares in February 2021:
- The company, which for many Americans was a nostalgic part of their childhood, was heading for insolvency at the time.
- (Predominantly professional) investors opened rows of short positions on the share.
- However, thousands of private investors came together on the internet platform reddit with the aim of saving the long-established company.
- It was agreed to buy Gamestop shares or to take out call options on the stock. The number of orders was sufficient to raise the share price from around 5 $ to over 500 $.
- The traders who had previously placed short sales for Gamestop now had to buy back shares at astronomical prices in order to close their positions again.
- The buyback in turn pushed the price of the securities up further and increased the losses of the short sellers - a so-called “short squeeze” occurred.
This resulted in huge losses for professional traders from hedge funds and banks. The affair also gained notoriety due to the fact that many neobrokers banned the purchase of further Gamestop shares under pressure from professional traders.
This illegal intervention in the market shows how important it is to choose a professional broker: CapTrader had never stopped trading in Gamestop shares.
Unlimited losses
The Gamestop affair led to huge losses for numerous short sellers. The hedge fund "Melvin Capital" lost several billion and had to cease trading. A perfect Example of the dangers of short selling!
- With long positions, your risk is always limited. Unless you use leverage, the most you can lose is your invested capital. At worst, an asset can fall to a price of zero euros, but it cannot become negative.
- However, there are no upper limits to prices on the stock exchange. If the price rises while a short position/short sale is open, traders make a loss. Since the price can theoretically rise indefinitely during the short sale, the losses are also unlimited.
- Sudden price increases occur time and again and can take on enormous proportions. The VW takeover by Porsche, for example, led to a shortage of available securities and caused prices to quintuple within a few hours. Anyone who had an open short position on VW stocks at the time also had to buy back the securities at five times the price.
When using leverage, this loss must be multiplied by the leverage - here there is a risk of losses that are many times higher than the capital invested! It can very quickly become Margin Call come. But we don't have to expose ourselves to these dangers without protection:
Short selling risks are manageable
When short selling, you do not simply have to accept the risk of infinite losses. There are methods available to you that can eliminate or at least drastically reduce the risks!
1. stop order
A stop order is an instruction to your broker to close a position as soon as a specified price is reached. In the case of short positions, this means that if there is a loss because the price of an asset rises and does not fall (as expected), the stop order pulls the emergency brake for you.
Traders can place a stop order at any point. In practice, a distance of 10, 15 or 20 percent has proven successful. If a loss occurs that exceeds your stop order, it will be triggered. Your broker then immediately places a market order, buys the asset for you and closes the open order.
Specialized forms, such as the Trailing stop-loss order, you can further limit your losses and optimize returns. A broker with suitable order forms is therefore essential for short selling. Unfortunately, there are still many brokers who do not even offer simple stop orders.
2. diversification
Sufficient diversification is the be-all and end-all of risk management: ideally, a short position should only make up a small part of your investment. In the event of failure, the damage will then be limited.
A short sale should always be regarded as a risky position. Ideally, it only accounts for a small percentage of a portfolio that is otherwise securely positioned.
3. hedging
Hedging refers to all measures with which we protect our assets from losses on the financial markets. A short sale is itself a popular form of hedging:
- If we own shares and expect the price to fall soon, a short sale offers effective protection
- We open a short position on our securities
- If prices fall, our shares lose value, but the short position gains
- Conversely, the long position (shareholding) ensures profits when prices rise, while the short sale loses
The risk of a short sale is therefore significantly reduced if we own the asset in question ourselves. Even in the event of a catastrophe (stock market price rises extremely sharply), we are protected as we can return the borrowed securities from our own holdings if necessary.
Other exciting opportunities arise from derivatives: for example, we can use options or futures to limit rising losses from unfavorable short positions. You can find out more about this in our reports on the topic Trade options and Future Trading.
Necessary collateral for a short sale
As you are selling a (borrowed) asset in a short sale, the cash balance in your securities account initially increases. Of course, you will have to repay the loan at a later date - so you only own the capital to a limited extent.
- For security reasons, CapTrader blocks the withdrawal of this cash until your short position is closed (assets returned).
- As a broker, CapTrader is responsible for the secure settlement between you and the lender of the assets.
- This also includes ensuring your solvency should prices rise.
Among other things, they must be in a position to make dividend payments to the lender. This is because the holder of the securities is entitled to profit distributions, even if they have just been lent to a short seller.
Good to know:
Due to the obligation to pass on the dividend payment to the owner of securities in the event of a short sale, the volume of short positions usually decreases somewhat shortly before the dividend payment.
Application examples and alternatives to short selling
When it comes to short selling, private investors and ambitious traders are divided: most market participants only take long positions and miss out on considerable returns.
It doesn't have to be: a short sale is simple and possible for almost anyone. We have summarized some exciting use cases for you below.
Simple short sale
The simplest form of short selling is certainly the short sale of shares when prices are expected to fall.
- If you expect the price of a security to fall, you can take a short position in it.
- Your broker will lend you the securities for the agreed period.
- At the same time, you should place a stop order to ensure that the short sale is closed out in an emergency.
- This is because if the price rises instead of falling, you will incur losses. These can theoretically be infinitely high (without appropriate safety precautions).
As an alternative to this “simple bet” on falling prices, derivatives such as Warrants or Certificates, are eligible. You only have a limited risk: the maximum loss is the value of your investment; with these products you cannot generate any debt beyond this.
Pairtrades
A pair trade is an exciting trading strategy that is not very well known among non-experts. The procedure is very simple:
- You pick a winner and let him compete against a supposed loser.
- The two assets must be linked, for example shares from the same sector or national currencies with close economic ties.
- If one value rises, the other should fall as a result.
- A long position is opened on the winner, while we trade a short sale on the loser.
The expectation is that capital will shift from the loser to the winner. In this case, you benefit twice, as you have bet on both the price increases of the former and the losses of the latter company.
Billionaire George Soros achieved fame and fortune through this approach in 1992: the Quantum Fund founded by him and Jim Rogers made a profit of more than one billion dollars through a pair trade on the currency market.
His currency bet against the British pound paid off: He borrowed large sums of British currency and exchanged it for the Deutschmark and the French franc. Both currencies rose in value, while the GBP actually collapsed, leading to huge profits for Soros.
Lend assets
A short sale doesn't appeal to you and you'd rather stick with your long positions? In this case you can also profit!
This is because assets have to be borrowed for every short sale. You can take on this role and lend your own shares. In return, you receive a large part of the fees that your broker charges the respective trader.
This is how it works with CapTrader:
- In your CapTrader account portal, activate the option “Stock Return Optimization Program"
- You can also deactivate the program at any time here
- There is no additional risk for your securities
- CapTrader passes on 50 % of the fees received to you
- The amount of income depends on the respective securities and demand
Depending on the current market interest rates, you can achieve a handsome additional return in this way. This option is particularly suitable for securities that you would like to hold in your portfolio for a longer period of time anyway.
Buy put options
Are you convinced that an asset will soon lose value, but don't want to sell short? Then buying a put option could be ideal for you instead:
- With a put option (long put), you acquire the right to sell an asset at an agreed price.
- You are guaranteed this sales price, even if the actual price on the stock exchange is much lower
- If the share price falls below the price agreed in the put option, you make a profit
- You have to pay a premium for the long put. If the market price does not fall as you had hoped and your plan goes wrong, this premium represents your maximum loss
The long put is therefore a simple and, above all, safe way to speculate on falling prices: The most you can lose is the premium invested! However, if successful, very high profits are possible if the price falls sharply on the stock market.
In our report on the topic Trade options you will find all the important information you need to use a first long put.
Conclusion: short selling is not just for professionals
Short selling is an important trading instrument that allows you to profit from falling prices. In its simplest form, a short sell involves borrowing an asset (usually a share, but other products are also possible).
You sell this asset immediately on the stock exchange and collect the equivalent value in cash. At the end of the agreed period, you must return the borrowed assets. You therefore buy them on the stock exchange to meet your debt. If the price of the asset has fallen in the meantime, you have made a profit.
In addition to this form of short selling, an efficient broker also offers you other ways to profit from falling prices. Derivatives such as certificates, warrants or options trading are available to you at CapTrader.
As is usual on the stock market, these methods also come with a risk! With a short sale, the amount of your loss is theoretically unlimited. It is therefore highly recommended that you use stop orders to protect yourself! Despite this additional effort, short selling is not only suitable for professionals.
The use of long and short positions opens up new return opportunities for you: If prices fall, you no longer have to wait for a recovery, but can make profits in the meantime.
Short selling brings additional benefits through pair trades, lending assets or as a hedge for your portfolio. To execute a short sale, you need a suitable broker that offers margin accounts. The selection of products should also be as wide as possible, as otherwise not all securities can be shorted.
