How to make profits from financial markets downturn ?


Most investors understand the most famous rule in financial markets, which is to buy stocks or cryptocurrencies at a low price and sell at a higher price point.

Financial markets experience cycles of ups and downs, and this rule helps to make profits when the markets are continuously rising.

But what do you do when financial markets experience a continuous downturn? This is where "short selling" comes in.

Nerdwallet published a report written by a group of experts on the importance of understanding short selling, its advantages, and risks.

At the beginning of the report, experts emphasize that "short selling" is a mechanism used by traders to profit from falling financial assets by selling borrowed assets - whether stocks or digital currencies - at a high price and buying them back at a lower price.

Usually, during short selling, the investor does not own the financial asset but borrows it through a broker, sells it at the current market price, then buys it back at a lower price, and returns what he borrowed to the broker. The difference between the selling price and the purchase price is the trader's profit or loss." 

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How to short sell a stock?

For example, if you think that Amazon's stock price of $100 will decrease due to poor company performance in the first quarter of the year, you would sell the stock (which is borrowed from the broker) and buy it back at $70. In this case, you would have a $30 profit margin from the sale and repurchase of the asset, in addition to the stock. It must be returned to the broker immediately with trading fees paid.

You can use the following formula when short selling:

  • (Selling Price - Buying Price) x Number of Assets - Transaction Cost = Profit.
  • Selling price = the price at which the trader sells the securities.
  • Buying price = the price at which the trader recovers the sold securities.
  • Number of assets = the number of assets sold by the trader.
  • Transaction cost = broker commission.

If the result of this formula is positive, you have made a profit from the transaction. If it is negative, you have suffered a loss.

Short selling through contracts

Traders can use "contract for difference" (CFD) to short sell stocks without owning the underlying asset.

CFDs are a contract between two parties: the trader and the broker.

At the end of the contract, the two parties exchange the difference between the stock price at the beginning of the contract and the stock price at the end of the contract."

"The mechanism of short selling involves many advantages and risks. Investopedia, the American investment website, published a report by Chris Seabury on the advantages and risks of short selling, including the following:

What are the pros  of short selling?:


Many investors resort to short selling to hedge during periods when important news may significantly affect the markets. In this case, the investor resorts to short selling to reduce the risk in case the price drops quickly when news comes out that prevents him from closing his selling positions quickly enough.

what are the risks of short selling ?

Unlimited risk

One of the main risks of short selling is the lack of limits to the risks that the investor bears in case the price of the asset he sold increases. If the investor's goal of short selling is speculation rather than hedging, then the increase in the stock price has no limits unlike the decrease that cannot drop below zero. Therefore, the risks of loss resulting from the increase in the asset are considered unlimited compared to the risks of decrease.

This means that the investor resorting to short selling bears the risk of losses that may exceed the total capital value he has and may become liable for additional amounts.

Dividend distribution risks

Companies announce a specific date for those who are entitled to receive dividends per share, and therefore, those who hold shares are restricted to a specific date, usually the date of the general assembly meeting, and they are entitled to receive dividends in this case.

When short selling on a date before the dividend entitlement date and selling the share after the entitlement period ends, the uncovered seller becomes indebted to the value of the dividends, which may exceed the value of the profits realized from the price drop. Thus, short selling has achieved profits resulting from the price drop, but lost them due to paying the dividend distribution that the share deserved."

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