How does short selling cause a stocks price to decline?

If we want to know the answer to the above question we need firstly to know what short selling of stocks is.

Short selling of stocks is when the stock is sold but the seller does not own the stock when it is sold.  This is done when the seller intends to purchase the stock at a later point in time when the stock is at a lower price.  People who do this are commonly called “short sellers” and their aim is to make a profit from the expected fall in price of the stock.

Usually the short seller is given the stock by the owner, usually for a fee, to sell and subsequently repurchase.  The stock is then returned to the owner of the stock.  When the stock price falls the short seller makes a profit because he sold the stock at a higher price than that which he later pays for it.  Should the stock price unexpectedly rise then the short seller will lose as he sold the stock for less than he subsequently has to pay to get it back.  This is risky business but many people have made huge profits by using this strategy.

People who criticize short selling suggest that short selling of stock undermines the basic value of the stock making a fall in the price of the stock greater than it would have been if the stock had not been sold by short selling.  It has often been noted that when a stock starts to fall short sellers sell while the price of the stock continues to fall.  Thus supporting the critics’ view that short selling makes the stock price fall even more.

Although there is some evidence to support the critics’ view on short selling, short sellers often target stock which is initially over valued.  Research has shown that short-sellers use a number of different strategies in their aim to make a profit and a considerable amount of short positions, which follow stock price falls show the stock price at a more realistic level rather than pushing it below its basic value.

Wondering how to short stocks?  Look for companies that have some basic problems for example if it is poorly managed or they manufacture a product, which does not have longevity.  These will be the most susceptible companies with stock that will be liable to fall.  By shorting stock on these types of companies you could make yourself a profit.


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