Introduction to Stock Short Selling Strategies: Five Key Points to Help You Capture Profitable Opportunities During Downward Markets

I. Understanding the Basic Principles of Short Selling Stocks

Short selling stocks (also known as shorting, shorting the market, or going short) is based on a simple core logic—profiting from a decline in stock prices. When investors judge that a certain stock will perform poorly in the future and its price will fall, they can sell it first, then buy it back after the price drops, and the difference is their profit.

This process is completely opposite to traditional long investing (buy first, sell later). The key to short selling is that investors initially do not hold the stock, so they need to “borrow stocks” from a broker, a process called margin trading or securities lending. The specific steps are: borrow a certain amount of stocks from the broker → sell to obtain cash → wait for the stock price to fall → buy back to close the position → return the stocks to the broker.

In practice, many short-term traders, day traders, or hedgers often target hot stocks that are prone to skyrocketing, short them when the opportunity arises, and quickly close the position after the price drops to profit from the spread. This is the most common profit model for short selling in the market.

II. Risks of Short Selling Techniques

It must be understood: Short selling is an extremely high-risk investment strategy. The goal of short sellers is to sell high and buy low, but if the stock price continues to rise without setting a stop-loss, losses can become unbounded.

The lowest a stock price can fall is zero, but there is no limit to how high it can rise. Therefore, short selling is a “profit limited, risk unlimited” trading method. Compared to that, most short sellers in the market are not aiming for profit but are using it for hedging or risk management.

III. Account Requirements for Short Selling

Short selling in Taiwan stock market: Margin trading account

To short sell stocks in Taiwan, you need to open a securities margin account. There are generally two types of stock trading accounts:

Cash trading mode: Buying and selling at real-time prices without leverage. For example, buying 1,000 lots of stocks at NT$10 per share costs NT$10,000. The profit is the net after deducting commissions.

Margin trading mode: Borrowing money or stocks from the broker to trade, but requiring a certain percentage of margin deposit beforehand. Margin trading and securities lending require opening a margin account.

Basic conditions for opening a Taiwan stock margin account:

• Must be a Taiwanese citizen aged 20 or above
• Have tax residency in the Republic of China (Taiwan)
• Account opened for at least three months
• Have executed more than ten trades in the past year

However, opening a margin account has some limitations—stock prices can only fall to zero, with no upper limit, leading to unlimited risk. Also, not all stocks are available for borrowing, making securities lending more difficult.

Futures account short selling

Futures accounts inherently have leverage, allowing both long and short positions. But futures have expiration dates; if the short position is held longer, it may require rollover, increasing costs. Not all stocks have corresponding futures, and liquidity must also be considered.

CFD short selling: a more convenient option

Contracts for Difference (CFD) have become a popular short selling tool in recent years. Compared to securities lending and futures, CFDs offer several advantages: support for both long and short operations, more flexible leverage, no expiration date, and usually lower trading costs.

The conditions to open a CFD account are relatively lenient:

• Must be a Taiwanese citizen aged 18 or above
• Passes suitability assessment and KYC procedures

Many international trading platforms offer CFD services, with lower minimum deposits and quick, easy account opening processes.

IV. Strategies for Choosing Short Selling Targets

Find markets with negative factors

Short selling requires a decline to profit, so selecting markets with negative factors is essential. For example: central bank rate hikes may cause certain currencies to depreciate, or specific industries facing demand decline.

It is recommended to prioritize US stocks because of their high liquidity, market freedom, and abundant derivatives, making short selling more feasible.

Identify stocks suitable for shorting

When choosing stocks to short, assess whether the current stock price significantly deviates from its intrinsic value. Possible reasons include:

• Short-term speculation: Market sentiment or irrational investor behavior causing short-term surges
• Fundamental deterioration: Declining revenue, shrinking net profit, or major earnings disappointments
• Technical signals: Price hitting short-term resistance levels or technical indicators showing sell signals

Short selling stock selection techniques

Companies with declining revenue: If a company’s total revenue drops significantly compared to previous years or shows negative growth, it indicates operational difficulties. Institutional investors may sell off heavily, causing the stock to decline.

Monitor large capital movements: Stocks that have been overbought for several consecutive days deserve attention, as this may signal a correction risk.

Industry top signals: If an industry has experienced a large rally and its P/E ratio is high, the bullish trend may have peaked.

Look for high-risk boundary stocks: Choose weak stocks at relatively high points or resistance zones, where the probability of downward movement is much higher than upward. The risk is limited, but the profit potential is substantial. Conversely, shorting at low levels reduces profit and greatly increases risk.

Assess downside potential: Normal price fluctuations yield minimal profits after deducting capital costs and transaction fees. Only targets with genuine shorting value are worth executing.

V. Practical Principles for Short Selling Stocks

Enter at relatively high points

“High point” does not mean shorting as the stock rises continuously, but rather when the current price is relatively high compared to future potential. For example, if fundamental analysis shows an industry is oversupplied and demand is declining, stocks with reasonable recent gains in such an industry are worth shorting; but if profits are growing and driving prices higher, shorting is counter-trend and prone to losses.

From a technical perspective, identify relative highs, previous peaks, or failed breakouts of resistance levels. Enter during a clear bearish trend and hold patiently to let time generate returns.

A typical case is US steel stocks: due to slow economic growth and declining steel demand, the stock fell from a high of US$47.64 in February 2018 to a low of US$4.54 in March 2021, a decline of over 100%. In such a clear bearish trend, investors only need to short at relative highs within the trend to achieve high-probability gains.

Focus on short-term trading

Short selling is usually a short-term trade, with day trading or even intra-hour positions. The advantage of short-term trading is quick profits and a short exposure to large rebounds.

Set stop-loss orders

Due to the high risk of short selling, it is essential to set stop-loss points when placing orders to control risk and prevent unlimited losses. Also, set take-profit points to close positions promptly when targets are reached.

Practice cautious capital management

Opportunities for short selling are rare, and trades are few. When a high-probability opportunity appears, allocate an appropriate portion of your capital to enter, ensuring you can withstand potential reversals. Diversification and batch trading strategies are not suitable for short selling; focus on high-confidence opportunities.

VI. Precautions for Choosing a Trading Platform

To short stocks, select a safe and reliable trading platform. When evaluating platforms, focus on:

Regulatory compliance and licensing: Confirm whether the platform is registered and regulated by recognized authorities. Many platforms attract investors with promotions but may run away with funds, causing losses. Larger, award-winning platforms tend to be more secure.

Trading costs: Compare commissions, spreads, and other fee structures to find lower-cost options.

Range of trading instruments: Some platforms only support stocks, ETFs, or commodities futures, with limited trading hours. Choosing a comprehensive platform that supports US stocks, forex, indices, cryptocurrencies, and other assets provides more trading opportunities.

Platform features: Ease of use, order execution speed, risk control tools, and overall trading experience.

Risk management mechanisms: Good platforms often have negative balance protection and automatic liquidation features to protect investors’ funds when prices reach certain levels.

VII. Final Tips on Stock Short Selling

The stock market is full of risks. Whether going long or short, it is essential to establish your own trading logic and risk management framework. Do not enter trades impulsively without confidence.

An important investment wisdom is: you can never earn more than your level of understanding. Prioritize capital preservation and steadily progress without incurring losses to achieve sustained profitability. Mastering short selling techniques requires time and practical experience. It is recommended to practice thoroughly in demo accounts first, and only proceed to real trading once your skills are mature.