After setting up your brokerage account you’ll be able to operate on financial markets. There, probably you’ll want to start by buying a stock. Stocks have many peculiarities that investors check in order to find an opportunity. Some of them are obvious and simple and some require a little bit of advanced knowledge.
But don’t worry! Financial markets are far simpler than most people believe.
So, if you’re interested in purchasing a share of a given company the first thing you should look is the value of its stocks. This process will take you no more than a few seconds, and the only thing you require is a decent internet connection.
The price changed too fast? Don´t be scared, it´s normal
If you’re new to investing and stock markets, you must be wandering why prices change so fast.
Stock exchanges are a marketplace where millions of people gather to trade financial instruments. In a matter of seconds, a stock could change from owner several times. The interaction of hundreds of people around the price of the stock naturally affects it.
If investors feel confident about a stock, they will show interest in it by purchasing shares of the company, this effect will push the price of the stock upwards. However, if for some reason, investors are doubtful about the performance of a company, they will start selling their shares pushing the price down.
What does it mean to short sell a stock? How does it work?
When opening a position on a stock there are only two options on which you can choose. You either are on a long position or a short position.
When entering on a long position on a stock you’re betting on a rise in its value. Thus, when you’re on a short position you are expecting the price of the asset to fall. The mechanism behind a short position is quite simple.
Imagine that you believe that the price of Ford’s shares will plunge. Now, you want to make profit from that opportunity. This is called “short selling” a stock. For this you’ll need a brokerage account, because at some point you’ll be borrowing the stock from them.
Let’s suppose the price of a Ford stock is $10 and you’re interested in short selling 5 shares. After opening your short position your broker will be lending you 5 shares of Ford valued in $10. In other words, you’ll be receiving $50 from your broker. Suppose that after a few days now the Ford share its trading at $8, confirming your belief about your investment.
In order to close your position, you must buy 5 shares of Ford to cover your debt with the broker. Hence, you’ll be purchasing 5 shares of Ford now valued on $8. So, from the $50 you borrowed from your broker you’ll be using $45 (5 shares at $8). This process is called “buying to cover”. After closing your position you’ll be making a profit of $5.
There are a few things that you must consider when opening a short position.
First, you must be careful with your estimations about the price, especially because, at least in theory, your losses could be unlimited. While on a long position your losses will be represented by price falls, thereby limited to a price of 0, on a short position your losses will be represented on price increases. This means that prices could raise without any nominal limits.
Also, markets tend to show growth. On the long run, markets tend to overcome crisis and downturns. This means that a short position could be considered as a bet against the natural trend of financial markets. So, you must be extremely careful when considering opening a short position.
Finally, when short selling a stock you’ll be borrowing stocks from other investors. Brokers make this possible almost in an immediate way. However, this mechanism includes payment of interest and the requisite of a margin account.