Can short selling stocks really make money when the market declines? 5 key points to help you see through it

Many novice investors in the stock market have a misconception — they believe stocks can only make money when they go up. But in reality, there are indeed people who profit handsomely during a stock market crash. This seemingly counterintuitive operation is called stock short selling (or shorting, selling short, or going short).

Not only stocks, but currencies, commodities, precious metals, and other financial products can also generate profits through short selling. Investors can use tools like CFDs, margin trading, futures, options, and more to execute short positions. But here’s a key point: Most people short not for profit, but for hedging. Although short selling can bring substantial gains in the short term, it is also fraught with risks and requires precise timing.

This article will delve into the essence of stock short selling, operational barriers, stock selection logic, and risk management, helping you understand this trading approach.

What is stock short selling? How to short for profit

The core principle of short selling is simple: predict that the stock price will fall, then sell first and buy later to profit from the price difference.

For example, an investor expects a stock to decline due to poor earnings, so they borrow the stock from a broker and sell it (short position). When the price drops to the expected level, they buy it back (cover or close the position), and the difference is their profit.

This process requires a key action called margin trading — borrowing stocks from a broker to sell, then buying back later to return. Compared to going long (buy first, sell later), the logic of shorting is the opposite, but the fundamental principle remains the same.

Market day traders, short-term traders, and hedgers often target hot stocks that are prone to skyrocketing / surge, looking for the right moment to short, and then close the position for profit after the price drops. This is the most common way to profit from short selling.

However, it’s important to note that not all countries permit short selling. For example, China completely bans shorting, Taiwan is relatively open but with some restrictions. To short stocks, using derivatives like futures or CFDs is more convenient.

Real-world example of short selling

Take gold as an example. An investor shorts at $2000, then gold price drops below $1900, touching a low of $1873, triggering a stop profit. The $127 difference multiplied by the position size is the final profit.

Whether in stocks, futures, or forex, as long as the trading framework is complete, short selling mechanisms exist.

But it must be emphasized: Short selling is a high-risk investment strategy. You never truly own these stocks; the goal is to sell high and buy low. But if the stock price moves in the opposite direction, losses can be unlimited — because there’s no cap on how high a stock can go.

What qualifications are needed to short stocks

Taiwan Market: Opening a margin account

Taiwan stock investment accounts are divided into two types:

Cash trading: Buying and selling at real-time prices without leverage, with relatively clear profit and loss. For example, investing in 1000 lots of stocks at NT$10 per share costs NT$10,000. Profit or loss depends solely on stock price movement.

Margin trading: Essential for short selling. Through margin financing and securities lending, you can borrow money or stocks from the broker to trade, but you must deposit collateral.

The requirements for opening a margin account in Taiwan are:

• Be at least 20 years old and a Taiwanese citizen
• Have tax residency in the Republic of China
• Have held the account for more than three months
• Have executed at least 10 trades in the past year

Details may vary between brokers, so inquire directly.

By using margin trading to short sell, investors borrow stocks from the broker to sell. If the stock price falls, they profit; if it rises, they need to buy back at a higher price to return the stocks. This is why people say short selling has “limited profit potential but unlimited risk” — the minimum loss is the principal, but the upside is unlimited.

Also, borrowing stocks is not always guaranteed, which limits the operability of short selling.

Derivatives market: a more flexible way to short

Compared to margin trading, futures accounts inherently have leverage, allowing both long and short positions. But futures have expiration dates, so long-term shorting requires rollover, which can be costly. Not all stocks have corresponding futures, and liquidity is a consideration.

CFDs are a more popular international tool. They allow both long and short positions, offer higher leverage, have no commissions, and no expiration date, making them more flexible for stock shorting.

Opening a CFD account generally requires:

• Be at least 18 years old and a Taiwanese citizen
• Pass suitability assessments and KYC procedures

Many platforms have low minimum deposits, and you can fund accounts with credit cards or bank transfers. The account opening process is quick and convenient.

Key considerations when choosing a trading platform

When selecting a platform, many prefer regulated institutions within the country for added security. However, it’s also important to recognize that some scam platforms attract funds with promotional offers and then run away.

Focus on these aspects when choosing a platform:

Security: Is the platform regulated by a recognized authority? Is it licensed and reputable? Check regulatory info and user reviews.

Trading costs and variety: Are the fees, commissions, and spreads competitive? Are there a wide range of tradable assets (US stocks, forex, indices, commodities, crypto)? Does the platform support 24-hour global markets?

Platform features: Is order execution smooth? Are risk controls in place (like negative balance protection, automatic liquidation)? Does it support mobile apps, web, or desktop?

Choosing a legitimate platform with comprehensive features, diverse trading options, and reasonable costs can greatly enhance your trading experience.

Before shorting, ask yourself: which stock should I choose?

First, look at the overall market: are there any negative factors?

Short selling profits only if the stock price declines, so the market must have negative catalysts. For example, imminent rate cuts by the Fed, declining demand in a certain industry, deteriorating company performance, etc.

It’s recommended to focus on US stocks — better liquidity, more transparent trading rules, complete derivatives, and many market participants, making shorting more feasible.

Next, analyze individual stocks: is the stock price deviating from its intrinsic value?

To determine if a stock is suitable for shorting, assess whether the current price is relatively overvalued:

• Unreasonable short-term surges: Stocks that have risen sharply due to market sentiment or momentum, detached from fundamentals
• Fundamental deterioration: Revenue decline, net profit shrinking, negative net profit margin, or major negative news like change of control
• Technical signals: Price hitting short-term resistance levels, overbought indicators

Practical stock selection tips

• Compare company revenue with previous years; significant decline or turning negative indicates poor performance, likely to be sold off by institutions
• Track large fund movements; if a stock is continuously overbought for several days, be cautious
• Observe industry performance; if an industry has already surged significantly and P/E ratios are high, the rally may be near its top

Most importantly: choose weak stocks at relatively high points or resistance zones. Limited downside risk with high profit potential makes them ideal short targets.

Conversely, shorting at low levels yields minimal profits but exposes you to huge rebound risks. Even if your trend judgment is correct, shorting stocks outside your understanding is unwise.

Principles and risk management for shorting

Enter at relatively high levels

“High level” here doesn’t mean blindly shorting during a rapid rally, but rather when the current price is no longer cheap relative to future prospects.

For example, if an industry faces long-term demand decline due to oversupply, stocks in that sector may rise temporarily but are irrational. Shorting at this point can wait for the price to revert to a reasonable level. But if the company’s profits are growing and driving the stock higher, shorting becomes a contrarian move, risking “gaps” (price surges) and losses.

In terms of operation, after selecting the trading instrument, wait until the stock price reaches a relatively high point — previous highs or key resistance levels fail. In a clear downtrend, entering at a relatively high point and holding patiently can yield good returns over time.

Take a well-known steel company as an example: in recent years, US economic slowdown caused steel demand to plummet, profits shrank year after year. The stock fell from a high in early 2018 to multi-year lows, dropping over 100%. In such a clear downtrend, investors can short at relative highs during the decline, with high probability of profit.

Use short-term strategies as much as possible

Short selling is usually a short-term operation. Especially for momentum shorting — completing entry and exit within hours or minutes, without overnight holdings. The advantage is quick profits and reduced risk of large rebounds.

Set strict stop-loss points

Short selling carries enormous risk. Every trade must have a stop-loss to ensure losses stay within manageable limits. This is the bottom line for survival.

Allocate capital scientifically

Opportunities for shorting are rare. It’s not suitable for diversified investments. But because these opportunities are precious, once you identify a high-probability setup, allocate your funds wisely to withstand potential reversals.

Final words

The stock market is full of risks and opportunities. Whether going long or short, it’s essential to have your own trading logic. Don’t rush into trades without confidence. Remember an old saying: You can never earn more than your level of understanding. Protect your capital and proceed steadily to achieve consistent profits.

Whether shorting or going long, the core is to understand the market, respect risks, and act with knowledge and action.