How to short sell stocks? Five key points to help you find opportunities during a declining market

Core Logic of Short Selling for Profit

Many novice investors in the stock market believe that stocks can only profit when they rise, and that falling prices only lead to losses. However, in reality, through short selling (shorting, selling short, going short), investors can also earn profits when stock prices decline.

The basic principle of short selling is simple: sell stocks at a high price first, then buy them back at a lower price after the price drops, and the difference is profit. During this process, investors initially do not hold any stocks and need to borrow stocks from a broker via margin trading (borrowing stocks), sell them, wait for the price to fall, then buy back to cover the position and profit from the price difference.

In contrast, traditional long positions involve buying first and selling later. Short selling is essentially the opposite trading logic. Whether it’s stocks, currencies, commodities, or any financial product, short selling can be used to profit during declines. Investors can utilize financial instruments such as CFDs, margin trading, futures, and options to execute short selling.

However, it is important to note that short selling requires precise timing; most market participants short not primarily for profit, but to hedge risks. Short selling can generate high returns in a short period, but the risks are also unlimited.

Eligibility Criteria for Stock Short Selling

Taiwan Stock Market Margin Short Selling: Requires opening a margin trading account

Taiwan stock accounts are divided into two types: cash accounts and margin accounts.

Cash trading involves directly buying and selling stocks at the current market price, with no leverage, and transaction costs equal to stock price × number of shares. If stocks rise, the profit after deducting fees is the gain.

Margin trading involves borrowing money or stocks from a broker to trade. Short selling requires opening a margin account, which enables margin trading.

To open a margin account, the following conditions must be met:

• Be a Taiwanese citizen aged 20 or above
• Hold tax residency in the Republic of China (Taiwan)
• Have maintained the account for at least three months
• Have completed at least 10 transactions within the past year (inclusive)

Through margin trading, investors can borrow stocks from brokers to sell. If the stock price falls, they profit; if it rises, they need to buy back at a higher price to cover. Since stock prices can go down to zero but have no upper limit, margin short selling is a “limited profit, unlimited risk” method, and it’s not always possible to borrow the desired stocks.

Overseas Derivatives Short Selling: Higher leverage, richer tools

Many investors turn to overseas markets for short selling because these markets are relatively freer, and financial instruments are more abundant.

Contracts for Difference (CFDs) are specialized short selling tools that allow both long and short positions, with higher leverage. They usually have no commission fees and no expiration date like futures. Opening a CFD account has a lower threshold, typically requiring to be at least 18 years old, complete identity verification, and suitability assessment.

In comparison, the trading volume of CFDs in Taiwan is very small, and the market scale is too limited to be suitable for short selling operations compared to overseas markets.

Key Methods for Selecting Short Selling Targets

Find markets and stocks with bearish factors

Short selling requires the price to decline to profit, so it’s essential to identify investment targets with bearish factors. On a macro level, signals include central bank rate hikes leading to currency depreciation, declining demand in certain industries, slowing economic growth, etc.

For individual stocks, suitable shorting conditions include:

• Deterioration of company fundamentals: declining revenue, net profit losses, major changes in controlling shareholders, etc.
• Short-term speculative hype: stock prices are driven up irrationally in a short period, deviating far from intrinsic value
• Technical signals: stock price reaching short-term resistance levels or previous highs

Due to good liquidity, mature market mechanisms, and abundant financial tools, the US stock market is the preferred target for individual investors to short.

Assess Profit Potential and Risks of Short Selling

When choosing stocks to short, look for weak stocks at relatively high points or resistance zones, making it unlikely for prices to continue rising in the short term, and with enough downside potential. This creates a “limited risk, ample profit” trading opportunity.

Specific criteria include:

• Company revenue showing clear decline or even negative profit, indicating very poor fundamentals
• Monitoring large capital flows, focusing on stocks with continuous overbought signals
• The industry has already experienced significant gains, with high P/E ratios, indicating a potential top in the bull trend

Shorting at low points is unwise, as profit margins shrink and there’s a huge risk of the stock rebounding from the bottom. While short selling may seem to offer limited gains, considering capital costs and transaction fees, only targets with genuine shorting value are worth operating on.

Practical Principles of Short Selling

Enter at relatively high points

The key is to identify the “relative” high point, not to blindly short just because the stock is rising. For example, if a shipping company’s industry outlook is bleak due to oversupply, even if the stock price temporarily surges irrationally, shorting when it returns to a reasonable level is suitable. Conversely, if the company’s profits are continuously rising, pushing the stock higher, shorting at this point is a contrarian move and can lead to significant losses due to short squeezes.

From a trading perspective, after selecting a target, wait until the stock price reaches a relative high point (such as previous highs or failed breakouts of key resistance levels), then enter during a clear bearish trend and hold, patiently waiting for the market to give returns.

Focus on short-term trading

Short selling generally adopts a short-term strategy, especially for momentum shorting, often completing trades within hours or minutes. The advantage of short-term trading is quick profits, with less time exposed to large rebounds.

Set stop-loss and take-profit points

Short selling is a high-risk trading method. When shorting, always set a stop-loss point to effectively control losses on each trade. Also, set reasonable take-profit levels to avoid giving back profits due to greed.

Scientific capital management

Since shorting opportunities are rare and trading frequency is low, it’s crucial to seize high-probability opportunities when they arise. Allocate a proportion of your capital based on your risk tolerance to ensure you can withstand potential reversals. Avoid uniform diversification; instead, concentrate capital on high-probability setups.

Case Analysis of Short Selling

Gold Trend Example: An investor shorts gold (XAUUSD) at $2000, then gold drops below $1900, reaching a low of $1873, at which point they close the position for profit. The difference of $127 per ounce multiplied by the position size is the profit gained.

US Steel Example: Due to slow US economic growth and declining steel demand, the company’s profits shrank year after year. The stock fell from a high of $47.64 in February 2018 to $4.54 in March 2021, a decline of over 100%. In this clear bearish trend, investors only need to short at relatively high points within the trend to have a high probability of profit.

Deep Understanding of Short Selling Risks

Unlimited risk, limited profit

This is the core risk characteristic of short selling. The lowest stock price can fall to zero, and the maximum profit is the original selling price; however, since there’s no upper limit to stock prices, if no stop-loss is set, losses can grow infinitely.

Short squeeze risk

If many investors short the same target, and short positions are closed simultaneously or positive news suddenly emerges, the stock price may rebound rapidly, causing large-scale losses for short sellers.

Margin costs and borrowing difficulties

In Taiwan, it’s often difficult to borrow all desired stocks for shorting, and margin interest costs are relatively high. Holding positions long-term can erode profits.

Regulatory risks

Some countries and regions impose restrictions on short selling. For example, China completely bans short selling. Taiwan’s market, compared to the US, has lower liquidity and fewer tools, limiting the flexibility of short selling strategies.

Summary and Recommendations

While stock short selling can indeed generate profits during declines, it is an advanced trading technique with risks far exceeding traditional long positions. Before shorting, investors must:

1. Learn thoroughly: Understand the mechanics of short selling and master risk management methods
2. Select stocks carefully: Only operate on targets with genuine shorting value
3. Maintain discipline: Strictly follow entry and exit plans, set stop-losses
4. Trade within capacity: Decide on position size based on personal capital and psychological resilience
5. Continuously optimize: Summarize lessons from practice and improve trading logic

Remember the investment adage: You can never earn more than your understanding allows. Do not blindly short without confidence. Only by understanding the market, making rational decisions, and managing risks properly can you navigate the complex stock market steadily and achieve sustained profits.