When you short a stock and it goes up, there are a few things that can happen, and it is essential that investors understand how they can act. You can either cover your position, hold, or continue to add. There is also a possibility that if the stock goes above a certain threshold you may get a margin call.
In this article, we will go over the different scenarios that can happen when you short a stock.
What to do when you short a stock and it goes up?
When you short a stock and it goes up, there are only 3 things you can do:
- Add to your short position
Depending on the specific situation and the reasons why the stock is moving upwards, you should carefully consider each one in order to know what is the best approach. You should also be aware that if the stock goes over a certain level, you will get a margin call from your broker.
Adding to your short position
When you short a stock and it goes up, you can add to the short position, just long-only investors average their positions when a stock dips. What you have to ask yourself is if this is just a short-term price fluctuation, or if there are any changes in the company’s fundamentals that do not justify being short anymore.
If the outlook for the company remains bearish, and nothing in your short thesis justifies the rally, you can add to your short position. If this is the case, perhaps the best approach is to cover and cut the loss right away.
Holding your short position tends to be the best approach when there are a few reasons why the stock is moving higher, and you want to assess the situation better. Sometimes it does not make sense to either add or close your short position since there could be new developments in the days to come. Also if you are running a long-short portfolio, holding can also be one of the main strategies.
Covering your short position makes sense when there are fundamental changes that affect your investment thesis. If this is the case, the best approach is to just cover and take the loss. Remember that you should cut your losses. Unprecedented situations happen in the market when you least expect them, and being able to take a loss is an important part of trading and investing.
How do you know what to do if you short a stock and it goes up?
Knowing how to proceed when you short a stock and it goes up, starts by understanding what made you short the stock in the first place. Ask yourself these questions:
- Has your short thesis changed?
If your thesis for shorting the stock has changed fundamentally, just cover your short position. This commonly happens when the company has great earnings results or news that something has changed internally, and the outlook is now more positive.
- Did something happen in the short term that completely changed the company’s outlook?
If nothing has changed fundamentally in the short term, you might consider holding or adding to your short position.
- What is driving the price?
Understanding what is the narrative behind the price action could also give you an insight into what to do when you short a stock and it goes up.
- Is it just normal price fluctuations or is there another reason why the stock is going up?
Stocks move up and down sometimes for no apparent reason. Volatility is to be expected, and understanding the reasons behind the price fluctuations can help you to determine what to do when you short a stock and it goes up.
How long can you hold a short stock?
You can hold a stock short for as long as you want. As long as you pay the interest on the stock you are borrowing, this is what is commonly called a borrow fee. It is also important that the stock does not go over a certain threshold, otherwise you will get a margin call.
Can you short a stock forever?
Technically you can short a stock for an indefinite amount of time, as long as the stock loan fees are paid to your broker, and your margin levels remain within a certain threshold. As long as you do not get a margin call, if the stock moves up significantly, you can have a short position pretty much forever.
When you short a stock when do you have to buy it back?
When you short a stock, there is no set date to cover your position. Therefore you can short a stock for a long period of time, as long as its price does not move up dramatically, and your minimum margin requirements are guaranteed. You should also consider that you will need to keep paying a borrow fee to your broker, for holding those shares.
These fees might a considerable amount of money if you short a stock for a long time.
When you short a stock and it continues to go up, you need to understand what is driving the price, in order to know what is the best approach. Try to avoid situations when the negative market consensus on a company has changed. You don’t want to keep shorting a stock that now has a brighter outlook.
Avoid situations holding sizeable short positions, where you can get easily margin-called.
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