Short selling and going long explained: How to grasp the market's two-way mechanism to earn profits?

In the investment market, there is an ancient saying: “Yin and Yang are the Way.” This phrase precisely explains the essence of the financial markets—alternating bull and bear markets, the interchange of Yin and Yang. Most retail investors think unidirectionally, expecting the market to always rise, but smart investors understand that market fluctuations always follow their own rules. Only by mastering bidirectional trading strategies can one seize opportunities in any market condition.

Long and Short Meanings: The Core of Market Dual Mechanism

Before explaining short selling formally, let’s first understand the key difference between long meaning and short meaning.

Long meaning: Investors are bullish on the market, buying assets at low prices and selling at higher prices later to profit from the price difference. This is the traditional “buy long” logic.

Short meaning: Investors are bearish on the market, borrowing and selling assets at current prices, then buying back at lower prices after the decline to profit from the difference. This is the reverse logic of “sell short.”

In simple terms, going long is “buy first, sell later,” while short selling is “sell first, buy later.”

Why is it important to understand the difference between long and short?

If the market only allows long positions, investors’ profit mechanisms will be greatly limited. Imagine during a stock market crash, investors who only go long are forced to hold losing positions or cut losses. But if they understand short selling, they can profit during downward trends—this is a hallmark of mature markets. Long and short complement each other, jointly building market liquidity and stability.

Advantages of Short Selling: Why Does the Market Need Short Mechanisms?

◆ Hedging Investment Risks

When the stock market is highly volatile and uncertain, investors with heavy positions face huge risks. Short selling can be used to hedge—like buying an “insurance.” For example, you hold a large position in a stock but are bearish in the short term; you can short the stock simultaneously. When the price drops, profits from the short position can offset losses in the long position.

◆ Suppressing Asset Bubbles

When a stock is seriously overvalued and a bubble is evident, the short mechanism can play an “automatic adjustment” role. Professional short sellers will short the stock heavily, causing the price to fall back and promoting valuation rationalization. This market self-correction mechanism significantly enhances market transparency and corporate regulation.

◆ Enhancing Market Liquidity

If only long positions are allowed, investors may choose to wait on the sidelines during bear markets, leading to liquidity drying up. Allowing short selling means that trading demand exists in both bull and bear markets, increasing participant activity and market liquidity, making buying and selling more convenient.

Main Methods of Short Selling: Choose the Tool That Fits You Best

Method 1: Stock Margin Trading (Margin Lending and Short Selling)

This is a direct way to short stocks. Investors need to open a margin account, borrow stocks from the broker, and sell at the current price. Later, when the price drops, they buy back and return the stocks to the broker.

Margin trading requires meeting certain thresholds:

• Minimum capital requirement: usually over $2000 in cash assets or securities holdings
• Maintenance margin ratio: always keep the account’s net assets above 30% of the total value
• Margin interest: varies depending on the short amount, typically between 7.5% and 9.5%

Advantages: straightforward and transparent. Disadvantages: higher threshold, more suitable for large-capital investors.

Method 2: Contract for Difference (CFD) Short Selling

CFD is a financial derivative where investors do not hold the actual asset but predict its price movements. The advantages of CFDs include:

• Multi-asset coverage: one account can trade stocks, indices, commodities, forex, and more
• Leverage flexibility: higher capital efficiency, small funds can participate in large trades
• Bidirectional trading: can go long or short easily
• Lower costs: no margin interest, lower transaction costs

CFDs are similar to futures; their prices are generally aligned with the underlying asset, effectively acting as a “pegged” buy/sell contract of the underlying.

Method 3: Futures Short Selling

Futures are standardized contracts based on assets like agricultural products, energy, or financial instruments for a future date. Shorting futures profits from price differences and can also hedge risks.

However, futures have notable disadvantages:

• Lower capital efficiency: require higher margin ratios compared to CFDs
• High trading thresholds: demand more capital
• Complex operations: dealing with expiry, rollover, possible physical delivery
• Risk management difficulty: margin calls can force liquidation, open contracts need active management

Not recommended for retail investors to short via futures; this tool is more suitable for institutional investors or professional traders.

Method 4: Inverse ETFs

Inverse ETFs are designed for bearish market views. They invest in assets that move inversely to a specific index, achieving “fund rises when the index falls.” Common inverse ETFs include:

• Products shorting the Dow Jones Industrial Average
• Products shorting the Nasdaq Composite
• Sector-specific inverse products

Advantages: professionally managed, risk is more controllable, suitable for investors who do not want to judge the market themselves. Disadvantages: higher costs due to complex derivatives replication and rollover costs.

Practical Case: How to Short a Stock?

Take tech stocks as an example. Suppose a stock hit a record high of $1243 in November 2021, then continued to decline. Technical analysis shows it struggles to recover the high. In January 2022, the stock attempts to break previous highs but fails. An investor chooses to short, with the process as follows:

Step 1 (Jan 4): Borrow 1 share from the broker, sell at the current price of $1200, temporarily gaining $1200.

Step 2 (Jan 11): The stock drops to $980. Buy 1 share to return to the broker, paying $980.

Step 3 (Settlement): Ignoring interest and fees, profit = $1200 - $980 = $220.

Within just 7 days, in a clear downward trend, a profit of about 18% can be achieved.

Key Points for Shorting Forex

The forex market is inherently bidirectional. Shorting forex works on the same principle as stocks—“buy high, sell low.” When investors believe a currency will depreciate against another, they can short.

For example, with GBP/USD, investors can sell GBP/USD on margin (e.g., 200x leverage). Suppose the opening price is 1.18039; when the rate drops 21 pips to 1.17796, profits are realized. In the case above, using $590 margin to short 1 lot of GBP/USD yields a profit of $219, a 37% return.

Forex prices are influenced by multiple factors:

• Interest rates: higher rates tend to strengthen the currency
• Balance of payments: trade deficits or surpluses affect demand
• Foreign exchange reserves: reflect currency stability
• Inflation: high inflation usually weakens the currency
• Macro policies: monetary and fiscal policies directly impact exchange rates
• Market expectations: investor sentiment and forecasts are crucial

Shorting forex requires comprehensive economic knowledge and risk management skills.

Risks of Short Selling: What You Must Know

◆ Risk of Forced Liquidation

Securities borrowed for shorting are still owned by the broker. The broker can demand the investor to buy or sell at any time, forcing liquidation. This may cause the investor to be forced out at unfavorable prices, incurring additional losses.

◆ Infinite Losses Due to Judgment Errors

The core risk of short selling is unlimited losses. Unlike long positions:

• Long positions: maximum loss is limited to the invested amount (if the stock drops to zero)
• Short positions: theoretically unlimited, as stock prices can rise indefinitely. For example, shorting at $10, if the stock rises to $100, loss is $90 per share; if it continues rising, losses grow without bound.

Under margin rules, if losses exceed the margin, forced liquidation occurs, potentially locking in huge losses.

Precautions for Short Selling

Short selling is not suitable for long-term holding

The profit potential of shorting is limited (max when the asset drops to zero), but the loss potential is unlimited. Therefore, short selling is best suited for short-term trades. Holding short positions long-term faces multiple risks:

• Price reversal and upward movement
• Broker recalling borrowed securities at any time
• Continuous interest costs
• Increased risk of forced liquidation

Keep position sizes reasonable

Use short selling mainly as a hedging or auxiliary strategy, not as a primary investment method. Position sizes should be within rational limits to avoid overexposure.

Avoid adding to losing positions

Many investors increase their positions when they make a wrong judgment or face losses, hoping for a reversal. This is very dangerous. Short selling requires flexible operation; whether in profit or loss, positions should be closed promptly to control risks.

Core Summary

Short and long are two wheels of the market, indispensable. Going long means bullish buying; going short means bearish selling. Together, they form a complete investment ecosystem.

The suitable shorting tools depend on your capital, risk tolerance, and market judgment. Regardless of the tool chosen, successful short trades follow a principle: only execute when you have a clear market conviction and a reasonable risk-reward ratio. Blind shorting often results in more severe consequences than blind longing.