What is Shorting? A quick guide

eToro offers a great variety of tools and assets for easy trading, and being able to sell an asset short is one of them. Below you can find a quick overview of what short selling is and how to perform it on the platform.

(NOTE: Before we continue, we have to give a disclaimer that the trading products offered by the companies listed on this website carry a high level of risk and can result in the loss of all your funds. CFDs are complicated instruments that are never guaranteed to provide you supplemental earnings.  In fact, Around 68% of all retail investors experienced a loss while trading CFDs. Make sure to keep this in mind before attempting to use the eToro platform yourself. All the information found on this website is not official trading advice and all practices shown are referenced for the use of the Demo account only.)

What is Shorting?

Shorting, going short or short selling is a type of a trading strategy where the trader makes a profit on a decline in price of a financial instrument. A position is opened such that its value will increase if the price of an asset goes down and is the most simple application of the basic “buy low and sell high” notion. It is generally used to benefit off declining markets or for hedging purposes.

How does it work?

Consider an example of a stock for simplicity. Let’s suppose that we anticipate a fall in its price and want to make a profit off this from a current price of 100$ to 80$, because it is overvalued, for example. How could we do this? By first borrowing that share from your broker and selling it at a current price of 100$, keeping 100$ of cash. Because you have borrowed a share you have an obligation to return it some time in the future. In the future the stock price however goes down to 80$, so you will only need 80$ out of 100$ you pocketed to purchase it back in the market and return to the broker. Therefore because of this price decrease, you have a net profit ot 20$ for yourself, being the difference between the original purchase price and the price of an asset after it declines later.

The transaction described above is one of the simplest forms of an agreement between a broker and a trader possible in short selling, with the broker lending a trader an asset, trader selling the stock, and then re-purchasing it later to return to the broker.

In case we are talking about a portfolio, going short on some assets may be useful for hedging (protecting) long positions in assets against the risks of a downside price movement; this process is often called short hedging.

Risks

Hopefully, you realized that the payoff of the whole strategy depended on your ability to repurchase the borrowed shares in the future at a lower price. No matter how well your prediction or price estimation techniques are, stock prices are highly volatile. Furthermore, if the price continues to rise there may be no limit to the losses on your position. Do not forget to research the asset you are trading and constantly monitor open positions to avoid potential losses of your trades.

Short Selling on eToro

Any kind of short selling on the eToro platform is done using the CFD (Contract for Differences) contracts and you can choose the level of leverage and the value of stop loss accordingly. CFDs are some of the most popular instruments used to trade stocks, currencies, cryptocurrencies, indices, and commodities worldwide because of their flexibility and the leverage they offer.

The terms of the transaction using an CFD are agreed upon beforehand between you and eToro and after it is complete the difference is settled; in this way there is actually no exchange of the actual asset in the process. Because the platform is regulated by multiple authorities the conditions of such a contract reflect the actual contemporary conditions of the market and hence the interests of both parties do not conflict.

Another aspect to remember while short trading is the fact that there is a spread (the difference between the Buy and Sell Price) to account for; spread incorporates the commission eToro requires for the trade. Do not forget to take a look at the Buy price of the asset as that is the price you will receive when you the position will be closed.

A note of caution

Do not forget that CFD are complex financial instruments that have a potential in amplifying your losses the same way they amplify your gains because of the leverage involved. Do make sure you understand the basics of trading with CFD and with leverage before you put you actual capital at risk.

Difference between short selling and selling a stock

A common confusion exists between what short selling and selling a stock means as the idea of selling an asset you do not own may be difficult to come around with. When you open a short sale position you are not actually selling any of the assets in your portfolio. Short selling using CFDs involves entering an agreement with the broker where you just settle the difference in prices at the opening and closing of the position at the end of the transaction without actually exchanging the underlying asset.

Hopefully this article gave you an understanding of what short selling is and how it works on the eToro platform, so you can now trade with more confidence and enjoy the process. Best of luck!

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Please note that CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 68% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Past performance is not an indication of future results. Trading history presented is less than 5 complete years and may not suffice as basis for investment decision.

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