How exactly to short stocks? Master these four key points, and you can profit even during a market downturn.

The Core Mechanism of Short Selling: From Selling to Covering

Many novice investors entering the market always believe that stocks only make money when they go up, and they lose money when they go down. But in reality, through the strategy of short selling stocks, investors can profit during downward price movements.

Short selling (also called shorting, going short, or shorting) may seem simple in principle but requires thorough understanding: an investor predicts that a stock will decline in the future, so they sell it first, then buy back (close the position) after the price drops, earning the price difference. In this process, the short seller initially does not own the stock, so they need to borrow (margin loan) the stock from a broker, sell it, and finally buy it back at a lower price to return to the broker.

For example, suppose a stock is shorted at 50 yuan, and three months later it falls to 30 yuan. Closing the position at this point yields a profit of 20 yuan. This is opposite to the logic of going long (buy first, then sell), but the profit principle is similar.

It is especially important to emphasize: The risk and reward of short selling are asymmetric. The maximum profit is limited to the stock price falling to zero, but the potential loss is unlimited—if the stock price keeps rising and you do not cut losses in time, your losses can grow infinitely.

Four Key Conditions Determining the Feasibility of Short Selling

First: Understand the local market’s short selling rules

Restrictions on short selling vary greatly across countries and regions. Some areas prohibit short selling entirely, while others allow it but with many restrictions. In markets where short selling is permitted, investors need to open specific accounts to operate.

Margin account route: Short selling via broker margin accounts requires meeting certain conditions—being at least 20 years old, having local tax residency, an account opened for over three months, and at least ten transactions in the past year. Risks include limited stock sources (not all stocks can be shorted), high borrowing costs, and all risks borne by the short seller.

Derivatives route: Using futures or contracts for difference (CFDs) for shorting is more flexible. These instruments are inherently two-way (can go long or short), leverage can be adjusted, and there are no borrowing restrictions.

Second: Choose targets with genuine shorting value

Not all stocks are worth shorting. The key is to find those that are seriously overvalued relative to their intrinsic value. Criteria include:

• Deteriorating company fundamentals: declining revenue, negative net profit, decreasing gross margin—these companies are highly likely to be sold off by institutions
• Industry cycle judgment: an industry that has already experienced a significant rise and valuation peaks is more likely to decline
• Technical signals: stock price hitting important resistance levels but failing to break through, or continuous overbought conditions

Most importantly, enter at relatively high levels. Shorting at low levels exposes you to large losses if the price rebounds. Conversely, shorting at high levels offers “more profit potential with less risk.”

Third: Set up risk control mechanisms

Short selling operations must set stop-loss points. The maximum loss per trade should be within 1-3% of total capital, to protect principal over multiple trades.

Additionally, set reasonable stop-loss distances based on stock volatility. Hot stocks with large swings should have wider stop-losses; small-cap stocks with lower liquidity should have tighter stops.

Fourth: Precise capital allocation

Opportunities for short selling are often limited, but once a clear short signal appears, it’s advisable to increase investment appropriately. This does not mean investing all funds in a single trade, but rather focusing on high-probability opportunities while keeping risks manageable.

Three Practical Tips for Short Selling

Prefer short-term trading: Short selling is best done with day trading or short-term strategies, lasting no more than a few weeks. The benefit is quick profits and avoiding black swan risks associated with long-term holdings. Holding short positions long-term involves many uncertainties, such as fundamental improvements or shifts in market sentiment.

Strictly follow the trading plan: Know your stop-loss and take-profit points before entering. Do not change your plan due to price fluctuations. Many short sellers become greedy when profits are realized, only to have the rebound wipe out all gains.

Avoid excessive leverage: Although some tools offer high leverage, beginners should not exceed 5x leverage. High leverage is tempting for quick gains but accelerates liquidation when the market moves against you.

Warnings About Short Selling Traps

Many famous short-selling cases in history ended in failure. In 2021, some short sellers persisted in shorting leading new energy vehicle companies, only to be trapped for months or even over a year. This shows that:

• Short selling cannot fight against long-term trends; going against the big trend often results in heavy losses
• Sudden reversals in company performance or policy support can catch short sellers off guard
• Shorted companies may buy back shares or take other countermeasures to push up the stock price

Therefore, before shorting, ensure you have thoroughly researched the opposing viewpoints, understood all scenarios that could prove you wrong, and set stop-losses sufficient to handle these scenarios.

Summary

Short selling stocks can indeed generate profits during declining markets, but it is a high-risk trading strategy. To succeed, you need to: clearly understand local market rules, accurately identify overvalued targets, strictly implement risk controls, and quickly enter and exit rather than hold long-term positions.

If unsure, it’s recommended to practice with a demo account first, gain enough experience, and only then invest real funds. After all, preserving capital and maintaining steady growth are the ultimate goals of investing.