Short selling, going short, or simply “shorting” is a trading method of initiating a trade with a sell order in anticipation of a downward moving market. While shorting is a common practice for seasoned traders, there are some significant hurdles for beginning traders to short selling certain assets. One of the most obvious benefits of trading futures is the ease with which traders of all levels can short their favorite markets.
Learn more about the ease of short selling futures in this short video:
What is Shorting?
The easiest way to understand shorting is through the old adage – “buy low; sell high”. If you reverse this statement to “sell high; buy low”, you’re describing short selling. Speculation of a down-trending market is cause for traders to want to sell a financial instrument at a high point, only to later buy it back at a lower price for a profit. While this is can be an awkward concept for new traders to understand initially, it’s fairly commonplace. Simply put, short-sellers profit when markets move down. Many traders will enter both long and short trades as part of their overall strategy. You can immediately see how trading both the long and short sides of a market during varying conditions can double your trading opportunities.
Limitations of Shorting Stocks
Another reason new traders may not be familiar with the concept of short selling is due to the limitations and restrictions tied to shorting the stock market. To sell stocks short, you need what is called a margin account. A margin account essentially allows you to borrow against your short trades and cover any potential losses. It also invokes the Pattern Day Trader rule, which requires stock traders to maintain a minimum account balance of $25,000 if they execute more than 4 roundtrip trades a week. Fear not though! Futures markets aren’t so complicated.
Benefits & Ease of Shorting Futures
With futures, you can trade as much as you want long or short, provided you meet the margin requirements for the contract you’re trading. With products such as the Micro E-mini Index futures, this means new traders with modest account balances can get started shorting. When you “short sell” a futures contract, you are buying a contract to sell at a (preferably) lower price in the future. In contrast to the stock market, no borrowing is necessary. You can see how this also contributes to a more level playing field between long and short traders, as the financial requirements for going long or short is equal for all traders.
Additional Benefits of Shorting Futures
While the benefit to short selling futures over stocks is immediately clear, some additional factors make shorting futures clear and simple. First, trading CME Group futures centralize activity on one exchange, whereas stock trading takes place across dozens of exchanges. With futures, you have a clear picture of what all market participants are up to.
A central marketplace also makes for larger, consolidated pools of liquidity. The consistent high liquidity in most popular futures markets makes getting in and out of trades easier since there are market participants ready on both sides of the market at any given time. Volume in stocks can vary greatly day-to-day and it’s not uncommon for equities traders to have difficulty entering or exiting a trade.
Futures are also used as a means of hedging, meaning futures investors will trade multiple markets at once. Commodity futures are commonly traded to both hedge risk in equity index exposure and diversify portfolios.
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