Stock Short Selling Basics: How to Profit from a Downtrend through Short Selling? Four Key Points You Must Know

Many beginners entering the stock market often only understand the single logic of buying to profit when prices rise and losing money when prices fall. However, there is indeed a group of people in the market who profit significantly during sharp declines in stocks—that is the so-called stock short selling. Whether it’s stocks, exchange rates, or commodities, any financial product can be profited from through a falling market. Investors can utilize tools such as margin trading, contracts for difference (CFDs), and futures to perform short selling operations.

However, it is important to emphasize that short selling is generally a high-risk trading strategy, not purely for profit; many institutional investors use it for hedging risks. For investors seeking quick gains, short selling is indeed very attractive, but only if they understand the mechanisms and risks involved. This article will explain the core logic of stock short selling in simple terms, helping you understand the five key elements of short position operations.

1. The essence of short selling: achieving profits through falling prices

Short selling (also called shorting, going short, or selling short) is most simply understood as: profiting from a decline in stock prices.

Suppose an investor predicts that a certain stock’s future performance will decline, and the stock price will inevitably fall. They can first sell the stock (short sell), then buy it back at a lower price when the stock drops further (cover), and the difference between the two prices is the profit. This principle seems simple but is the core logic of short position operations—completely opposite to the traditional buy-low-sell-high approach.

The problem is, initially, the investor does not own the stock, so they need to borrow the stock from a broker before selling it. This process is called “margin borrowing” or “short borrowing.” The process is as follows: borrow stock from the broker → sell it → buy it back after the price drops → return the stock and pocket the difference.

In practice, many short-term traders and hedgers target hot stocks that are prone to skyrocketing, choosing the right timing to short, and then closing the position after the price retraces for profit. This is the most common way to profit from short selling.

It should be noted that short selling is not allowed everywhere globally. For example, the Chinese market completely bans short selling. Taiwan, while relatively open, has less liquidity and fewer financial instruments compared to the US. Therefore, many Taiwanese investors choose to use futures or CFDs for short selling, which is more convenient and flexible.

Short selling profit example

Taking gold (XAUUSD) as an example: an investor shorts at $2000 (sells), and when gold drops below $1900, touching a low of $1873, they close the position to take profit. The $127 difference is the profit. If the position size is large, this profit can multiply exponentially.

As long as the trading market framework is complete, a short selling mechanism will exist. This applies to stocks, futures, or forex markets. Some traders even make a living by shorting stocks, observing trends calmly, and finding the right entry points to achieve stable profits.

But here, it must be emphasized: short selling is a highly risky strategy. You do not own these stocks, and your goal is to sell high and buy low. But if the stock price moves upward instead, the losses can be unlimited.

2. Qualifications and conditions for participating in short selling

Margin short selling in Taiwan stock market requires opening a credit account

Stock investment accounts are divided into two types:

Cash trading account: no leverage, investors trade at real-time prices. For example, buying 1000 lots at NT$10 per share costs NT$10,000; gains or losses are calculated after deducting fees.

Margin trading account: allows financing and margin trading, meaning borrowing money or stocks from the broker to trade. The borrowing limit is subject to margin requirements.

To open a margin account for short selling, the requirements are:

• Must be a natural person aged 20 or above
• Hold ROC (Taiwan) tax residency
• Account opened for at least three months
• Have completed at least 10 transactions in the past year

Different brokers may have slightly different opening requirements; investors should inquire individually.

Through margin trading, short selling can be performed by borrowing stocks from the broker to sell, profiting when prices fall, and buying back when prices rise. Since stock prices can go down to zero but have no upper limit, this method carries infinite risk and limited profit potential. Also, borrowing stocks is not always guaranteed, so many turn to futures accounts.

Futures accounts inherently have leverage, allowing both long and short operations, but they have expiration dates. Holding positions long-term may involve rollover costs, and not all stocks have futures contracts.

Many investors choose to operate in overseas markets. CFD (contracts for difference) tools are especially suitable for short selling; compared to Taiwan’s domestic market, international CFD trading is more active and offers more tools.

Opening international CFD accounts is more convenient

CFD accounts have lower barriers to entry; with just an ID card, health insurance card, bank card, etc., you can apply online. Requirements include:

• Being a natural person over 18
• Passing suitability assessment and KYC procedures

Once funded, trading can begin. Some reputable platforms require only $50 USD minimum deposit, supporting credit card or bank transfer.

CFD is a margin trading mode; when shorting stocks, select “sell,” set leverage, stop-loss and take-profit points, and trading volume on the order page, with the required margin clearly displayed.

3. Choosing the right trading platform and risk management

Key considerations for platform selection

When choosing a trading platform, Taiwanese investors tend to prefer domestic institutions for regulatory protection. But if considering international platforms, focus on the following:

Legality and regulation: Confirm whether the platform is registered and regulated by the relevant authority in its country. Many unregulated platforms lure funds with promotions, then run away after collecting enough capital, causing investors to lose everything. Always verify the platform’s license.

Trading costs and features: After confirming safety, consider fees, variety of trading instruments, and platform usability. Some platforms only support stocks, ETFs, or commodities futures, with limited intraday trading hours, reducing trading opportunities. Choosing a comprehensive, strong platform that meets your needs is crucial.

It is recommended to prioritize licensed, regulated platforms. International well-known platforms are often authorized by authorities like ASIC, FCA, etc., with large global user bases and better fund safety. These platforms typically feature:

• Zero commissions or low spreads
• Trading US stocks, forex, commodities, cryptocurrencies, CFDs, and more
• Leverage up to 200x or more
• 24-hour global market access
• Multi-terminal support (mobile app, web, desktop)
• Negative balance protection, automatic liquidation at certain price levels

The importance of risk management

Leverage trading can cause losses, so it’s essential to choose platforms with risk protection mechanisms. Many regulated platforms have automatic stop-loss features that close positions when the market moves unfavorably, preventing unlimited losses.

4. Stock selection logic and timing for short selling

Target stocks with negative catalysts

Short selling requires a decline in price, which is supported by negative factors. For example, if a central bank is about to cut interest rates, the currency may weaken; or if industry policies change, demand may decline. These are suitable backgrounds for shorting.

Compared to individual stocks, it’s recommended to prioritize shorting US stocks. The US market has better liquidity, a free-market system, and abundant derivatives, making short operations more advantageous.

Identifying stocks worth shorting

To determine if a stock is worth shorting, assess whether the current price deviates excessively from its intrinsic value. Common situations include:

Short-term emotional hype: A stock surges excessively due to irrational market behavior, far beyond fundamentals.

Fundamental deterioration: Revenue decline, significant profit drops, major negative news like change of control, etc., which the market has not yet fully priced in.

Technical signals: For short-term traders, price hitting resistance levels, overbought indicators, etc., are shorting signals.

Practical stock selection tips

Focus on revenue and profit trends: If a company’s revenue is significantly declining or turning losses, the market will eventually sell off, and the stock price will fall.

Follow institutional fund flows: Stocks that have been overbought for several days may indicate institutions are quietly reducing holdings.

Observe industry cycles: When an industry has already experienced a large rally and P/E ratios are high, the bull run may be nearing its top, and risks are being released.

Identify relative high points in weak stocks: Choose weak stocks at or near resistance levels or previous highs, as they have a low probability of further upward movement in the short term, with more room to fall, thus limiting risk and increasing profit potential.

Conversely, shorting at low levels offers limited profit potential and exposes you to significant risks of rebound or trend reversal. “Limited profit, unlimited risk” is the principle—if the stock keeps rising and you don’t set a stop-loss, losses can grow infinitely.

Therefore, when shorting, it’s crucial to evaluate whether the stock truly has enough downside potential. After deducting capital costs and transaction fees, profits are often minimal unless the stock has genuine shorting value. Only targets with real shorting potential are worth risking for.

The same applies to currencies and commodities. For example, JPY/USD has been declining since 2021 with a clear trend and high win rate, suitable for shorting. But if the yen is already weak and the Bank of Japan ends negative interest rates, while the dollar weakens due to rate cut expectations, shorting the yen again would be unwise.

5. Core principles of short selling operations

Entering at relatively high levels

“High level” does not mean blindly shorting as the stock rises, but rather when the current price is relatively expensive compared to future expectations.

For example, if the shipping industry faces oversupply and declining freight rates, and shipping stocks are unreasonably rising, shorting to wait for a return to reasonable prices is suitable. But if the company’s profits continue to grow and drive stock prices higher, shorting becomes counter-trend and risks being squeezed (price rising sharply), leading to huge losses.

From a trading technique perspective, after selecting a target, wait until the stock price reaches a relatively high point—such as a previous high or a failed breakout of a key resistance level—to enter short. In a clear downtrend, entering at a relatively high level and holding, then waiting for time to work in your favor, is a common approach.

Take US Steel (NYSE:X) as an example: in recent years, slow US economic growth, declining steel demand, and shrinking profits created a basic fundamental shorting scenario. X’s stock price peaked at $47.64 in February 2018 and then declined sharply, clearly in a bearish trend. By March 2021, it fell to $4.54, a drop of over 90%. In such a clear downtrend, investors can short at relatively high points during the process and likely profit.

Use short-term strategies as much as possible

Short selling is generally a short-term operation, sometimes even intraday, with positions closed within hours or minutes, avoiding overnight holdings. The benefit is quick profits and smaller risk of large rebounds.

Always set a stop-loss

The risk of shorting stocks is extremely high. When shorting, you must set a stop-loss to ensure each trade’s risk is controlled. Trading without a stop-loss is gambling on luck, not real investing.

Money management and opportunity selection

Since shorting opportunities are rare and only considered when there is clear value, diversification and averaging down are less suitable. Short opportunities are few, but when a high-probability setup appears, allocate appropriate capital to ensure you can withstand potential reversals.

The stock market is full of risks and opportunities. Whether going long or short, you need to develop your own trading logic and risk awareness. If you are not confident, it’s best not to participate impulsively. After all, no one can earn beyond their knowledge; preserving capital and maintaining steady growth is the fundamental way to achieve sustained profitability.