Can You Short on Robinhood? What does it entail? We tackle all that and more in this article!
Since its founding, Robinhood has led the movement of democratizing the finance industry with commission-free trading. Through its website and app, the platform has served as a venue for countless internet users to earn a pretty penny.
(Speaking of A Pretty Penny, Check Out My Post Robinhood Penny Stocks to Watch)
That being said, many have begun to wonder if it's possible to engage in Short selling within its system. Though not a particularly common investment practice, even by cryptocurrency standards, it is a fair enough question to warrant more in-depth research into the matter.
I've been trading stocks for nearly 11 years now, and know a thing or two about the market.e
By the end of this article, you'll learn:
- What Short Selling Is
- The Best Short Selling Strategy
- If It's Possible to Short Sell Stocks on Robinhood (Spoiler, No, You Can't)
- Alternatives to Robinhood for Short Selling
- And Much, Much More...
For that very reason, we have gathered all the relevant info necessary and arranged them in a neat little package here for your education.
What is Robinhood?
Assuming you are a novice to the complex world of online trading and cryptocurrencies, you're probably wondering what Robinhood is and how it works.
The company was founded in 2013 and is currently based in Menlo Park, California. The main objective of the platform was to democratize the financial industry by essentially giving users the ability to govern their finances and engage in trading themselves.
Where banks and brokerages used to fulfill this role in exchange for commission and a host of other fees, Robinhood offers commission-free transactions. They also provide uniform interest rates, no account minimums, and install a host of safety protocols which protect small-time investors as much as it does the established ones.
Robinhood earns from this setup by simply extracting rebates from market makers and venues -- a form of compensation Robinhood receives as a broker who directs orders to certain parties to carry out trade executions.
The platform has quickly expanded since its founding -- reaching revenues well into the billions of dollars and expanding operations to mobile apps.
All that sounds wonderful but one has to keep in mind that the platform, like any kind of investment platform, comes with its own set of risks that a trader needs to prepare for. This is especially true for young and inexperienced traders since there are stories about those kinds of investors who received devastating losses on high-risk investments.
What is Short Selling?
Short selling is a relatively common but controversial practice even in traditional investment settings.
In simple terms, short selling occurs when an investor sells assets he knows are about to decrease in value. They sell borrowed shares at their original price and buy them back at the lower price, walking away with their original assets plus the profit from the sale.
Easy enough to understand but know that this is highly risky if you speculate wrong. What if, for instance, prices rise instead of fall? You would then be incurring a loss. On top of that, they would still have to pay the fees and charges associated with borrowing stocks.
Short selling, by its very nature, requires research and your ability to make correct predictions on the twists and turns of the market -- which is known for being volatile. Many have made it big when they called prices right but just as much have lost big time due to misinformation. For this reason, only a limited amount of brokerages offer the ability to open a margin account and engage in short selling. Even if it were offered, the brokers will tend to charge you a higher rate for the borrowing stocks.
It goes without saying the short selling is a gamble and many have called it unethical since it capitalizes on the perceived loss of a company.
How does one Short Sell?
Now let us say you have a little extra money lying around and would like to try your luck in some short selling. Who knows, maybe you'll be one of those who get it right and walk away with more than you started with.
In order to get started short selling, you'll need to open a margin account with a broker. A margin account allows you to borrow stocks and funds from your broker which a standard account does not have the authorization to do. First things first, the main steps to start short selling once you have a margin account is:
Step 1: Identify a Short Candidate
You don't need to be in the middle of a stock market crash to short a stock, but as you will learn here, you will be required to do some research.
You need to be able to have an eye on irregular price changes in the stocks within a market and make an educated call on the future prices of those stocks.
A good sign to look out for is sudden and dramatic increases in the price of a stock. If this hike in prices is apparently unexplainable, then you have a good candidate for short sell.
Other things to look for is:
- A high volume of Trading
- The particular stock is being traded above its average 52-week high
- The price is rising and fast, too fast.
- The stock is rallying despite the rest of the market being in decline or remaining relatively flat.
All this points to a likelihood that the stock's price is likely to plummet soon. This allows an investor to take a position for borrowing and the eventual selling of that stock.
Step 2: Work out an Exit
As important as knowing which stocks to borrow, you need to know when to exit too. You'll need to be aware of the stock's price history and how much you expect its price to decrease. Set a limit of decrease in which you can finally buy back the stocks. What your trying to avoid is the prices turning around and beginning to increase, which might cause a short-covering rally (more on this below) and shrink your potential profits to nothing in the blink of an eye.
You need to make provisions for preventing you from possibly waiting for the price to be as low as possible only to see the prices rebound -- this creates opportunity costs.
Step 3: Open the Position
Once your plan is ready, it's time to borrow the stock you believe will decline. If by chance, you already own the stock you believe will decline, then this is called "shorting against the box". It works the same way really as shorting from borrowed stocks.
Note that you do this because you expect the declining prices to turn around and regain their value eventually. If you think that the price of the stock will never recover then be happy you sold it for its original value and just invest your money somewhere else.
Step 4: Cover your position
"Covering" is a term used in investment language which means you are buying back the same amount of borrowed stocks that you sold. You'd be doing this once your predictions prove true and the price of the stocks begins to decrease.
Be sure to follow the news religiously and work out an automatic buying strategy. Essentially, cover all your bases.
Can You Short on Robinhood?
Currently, there are no direct ways to engage in short selling in Robinhood.
The system that the platform operates simply does not make it conducive to short selling in the traditional sense.
Here's A Simple Alternative to Robinhood:
Instead, what some investors do is they operate their Robinhood account normally and play with the earnings from that to engage in high-risk shorting on Webull or other online brokerages.
You can also put options or calls on sale which is effectively like shorting but, again, such a position is not available through Robinhood.
It is unknown whether or not there are plans to make this available but there is a host of content out there claiming that they found a way to currently do so.Though these methods seem like short selling, they are effectively quite different.
Is Short Selling Legal?
According to Robinhood's own article posted on their site, Short selling is not illegal in and of itself. Though many critics state how unethical it is to bid on the decline of a company, many noted economists have come to believe shorting is a necessary component in keeping the market liquid.
There are types of shorting though which are considered illegal and even detrimental to the health of the market.
One example is naked shorting which was banned by the SEC during the Financial Crisis.
Naked Shorting occurs when a person tries to trade a stock he hasn't borrowed yet or that does not even exist. Only real stocks that are owned or borrowed first can be short-sold. As for the types of stocks that are often shorted, it really does vary from week-to-week. Tech stocks are popular, as are 'meme stocks' such as AMC and GME lately.
Using short sales to induce others to buy and sell a stock is also prohibited practice and is subject to steep fines from the SEC. Even if you're not planning on shorting, it's good practice to know when to sell a stock.
Brush up on the short-selling laws of your state or country and determine what the specific rules are for these kinds of transactions.
What are the Advantages of Short Selling?
- Of course, the main advantage of short selling is potentially large returns one can obtain while still keeping their assets intact. This has made them highly attractive to investors despite the risks involved.
- Some experienced investors use short selling as a short-term hedging tool to minimize the risk of other investments.
- It is also a great way to provide liquidity to the market which lowers the prices of stocks.
- If you have stocks that are just lying around or wish to capitalize on a possibly negative situation, short selling is perfect for that.
What are the Disadvantages of Short Selling?
- The main and most obvious disadvantage of short selling is the higher than usual amount of risks involved. There is a possibility for stocks to decrease infinitely and an error in judgment can see you buying back a stock that never regains its value.
- On the other hand, say you borrow a stock you predict will decrease in value but never does. You shelled out money intending to sell stocks and buy them back for cheaper but are instead stuck with a borrowed stock.
- There is also the danger of short-covering rallies. This takes place when a lot of investors scramble to cover their short-selling positions all at once. They might do so because the price of the stocks took a sudden turn towards increasing value.
- The increase in inactivity leads to the price of the stock increasing more -- potentially creating loss or at least shrinking the profit margin.
- Finally, short selling is not exactly a practice any investor can engage in. It takes up a higher than average cost compared to standard investments and the very speculative nature of it means that only experienced investors only ever partake.
Verdict and Conclusion
The starting question we began with was whether or not you could short sell on Robinhood. Though the platform can earn you great profits with its many market offerings, the answer is a plain and simple no, you can't short sell on Robinhood.
There are many YouTube videos and articles out there that try to explain how certain trading options can be used just like short selling but this only serves to confuse. Short selling, so far, is not intended to be a part of Robinhood's makeup.
Another more important question you should ask yourself though is: would you want to?
The risks involved in this form of investment are enough to deter even the most courageous of investors and with good reason. Many young investors searching for a get-rich-quick investment famously lost everything on short selling and we would be remiss if we didn't learn from their mistakes.
That being said, there is something to be said about their ability to garner large amounts of income compared to other long-term investments. The very reason they exist and are allowed to continue existing is a testament to their popularity among investors.
In the end, you have to decide what risks you are willing to take. It is up to you if the potential gains outweigh the potential losses and whether or not your predictions are work taking that step. All we can say is be prepared for any or all outcomes and perform your due diligence before tying your money up into anything so risky.