The lucrative trap of short selling stocks: Why is smart money waiting for the decline?

Short selling stocks sounds very enticing—making money when stock prices fall, which is completely opposite to most people’s trading logic. But this is also why those who make big money in the market often master this skill. However, short selling stocks is not as straightforward as buying, and it involves mechanisms and risks you must understand.

The Essence of Short Selling: Borrow to Sell, Buy Back at Lower Price

The core logic of stock short selling is simple: sell first, buy later, and profit from the price difference. When you judge that a stock will decline, you need to borrow the stock from a broker first, then sell it immediately. When the price drops, you buy it back and return it to the broker. The difference between the selling and buying price is your profit.

For example, in gold trading, if you short at $2000, and later gold drops to $1873, closing your position here results in a $127 profit per ounce. If your position size is large, profits multiply.

But short selling has a fatal flaw: unlimited risk and limited profit. The stock price can fall to zero, but there is no ceiling on how high it can go. This is why many traders, although they have made big money from shorting, often end up losing everything due to a single misjudgment.

Conditions Necessary for Short Selling

Margin Short Selling in the Taiwan Stock Market

If you want to short stocks in Taiwan, you need to open a Stock Credit Account. This differs from a regular cash account—credit accounts allow you to borrow money or stocks from the broker for trading.

Opening conditions include:

• Being a natural person over 20 years old
• Holding ROC tax residency
• Having had the account open for more than three months
• Having completed at least 10 transactions in the past year

Note that the biggest issue with margin short selling is the lack of available stocks to borrow. Stocks are limited in quantity, especially popular stocks, which are hard to borrow. Even if your judgment is correct, you might miss the opportunity because you cannot borrow the stock.

Futures and Contracts for Difference (CFDs)—More Flexible Options

Compared to margin short selling, futures inherently have leverage, allowing both long and short positions. But futures have expiration dates, and long-term short positions require rolling over, which incurs additional costs. Also, not all stocks have corresponding futures contracts.

CFDs eliminate many of these restrictions. They support two-way trading, have no commission, and no expiration date. In international markets, CFDs have become the preferred tool for professional traders. Opening an account only requires: being over 18 and passing KYC verification, with a minimum deposit as low as $50.

How to Identify Short Selling Opportunities

Find assets with clear negative catalysts

Short selling requires a reason—there must be a driving force behind the decline. On a macro level, pay attention to changes in central bank policies, deteriorating economic data, geopolitical risks, etc. For example, if a country is about to raise interest rates, its currency might appreciate while others come under pressure; or if a sector is cyclically declining, related listed companies’ stock prices will face long-term pressure.

Due to liquidity and abundant derivatives, US stocks are the best choice for shorting. A classic example is US Steel (NYSE:X)—due to slowing US economic growth and declining steel demand, the stock plummeted from $47.64 in February 2018 to $4.54 in March 2021, a decline of over 90%. In such a clear bearish trend, entering at a relatively high point can be profitable.

Choose stocks truly worth shorting

Not all declines are worth participating in. The key is to judge the deviation between the current stock price and intrinsic value.

Observe these signals:

• The company’s revenue has been declining for consecutive years, even posting negative profits, indicating a collapse in fundamentals
• Stocks showing continuous overbought signals should be approached with caution, as institutional funds may be quietly withdrawing
• The industry has already experienced significant gains and is overvalued, with a high risk of a top in the bullish trend

The ideal short candidates are those at relatively high points or resistance levels—weak stocks with large downward potential and small upward risk—offering the best value. Conversely, shorting at the bottom can occasionally be profitable, but the risk is huge because the rebound potential is unlimited.

Core Principles for Executing Short Positions

Wait for high levels before taking action

Here, “high levels” do not refer to absolute prices but to prices that are relatively expensive compared to future value. Timing is crucial—either enter at the early stage of a trend reversal or decisively when technical analysis shows a clear failure to break through a resistance level.

For example, the USD/JPY has been in a one-way decline since 2021, showing a very obvious downtrend. But be aware that if the Bank of Japan changes policy and the yen appreciates, continuing to short becomes a contrarian move with increased risk.

Short-term thinking is essential

Short selling is mostly a short-term operation, especially since day traders often complete a full trading cycle within hours or even minutes. The advantage is quickly locking in profits and avoiding overnight risks associated with black swan events.

Set stop-losses

The reason why short selling risk is unlimited is that you are fighting market uncertainty. Every short position must have a clear stop-loss point—this is the bottom line of risk management. A professional trader would rather miss 100 opportunities than let one mistake wipe out the account.

Prudent capital allocation

The win rate for short selling is often lower than for long positions, and opportunities are fewer. Therefore, when a truly high-probability opportunity arises, you need to have enough ammunition. This means maintaining discipline in normal times, avoiding wasting capital on low-probability events, and reserving sufficient positions for those genuinely valuable short candidates.

Practical Trading Advice

Whether using margin, futures, or CFDs for stock shorting, the core elements are the same—choose the right direction, control risks, and know when to exit.

Many beginners tend to be overconfident when shorting. The market is full of black swan events, and even the smartest traders can make wrong judgments. Therefore, humility in risk management is far more important than chasing maximum returns.

The final advice is: do not attempt short selling impulsively without full confidence. Short selling can indeed profit during market declines, but that money belongs only to those who truly understand the risks involved and have a complete trading system. Steady progress and preserving capital are the keys to long-term profitability.