AI Tools Make Short-Selling Possible with Algorithmic Trading

AI technology has led to new advances in algorithmic trading which has made short-selling a much more viable endeavor for many investors.

ai drives benefits of algorithmic trading
Shutterstock Photo License - Alexander Limbach

Artificial intelligence is driving a number of changes in the financial sector. We pointed out that AI has created new opportunities for investors purchasing real estate stocks. However, it is also creating unique trading opportunities for those using nontraditional investing decisions.

One of the ways that smart investors can use AI is with short-selling. Before you can appreciate the benefits of using AI for short-selling, you will need to understand the practice.

What is Short-Selling and How Can AI Technology Make it Easier

Short-selling? What’s that. Many have heard of this term but seem to be confused by it. How do you profit when the value of an asset drops? That kind of makes little sense…but it does, and we’ll see how.

Short-selling is the act of selling assets, usually, securities or commodities, that one does not own at the time, with hopes of buying them back at a lower price before the delivery time.

In short-selling, you open a position by borrowing shares of a stock or other asset that you believe will reduce in value. You then sell the borrowed shares to buyers willing to pay the current market price. Before you return the shares at an agreed date, you’re betting that you’ll be able to buy them back at a lower cost and pocket the difference.

You can make a lot of profit from short-selling and, on the other hand, a lot of losses. In fact, you’re more likely to lose than gain, so be careful. The amount of profit you can make is predictable because the price of an asset can theoretically only drop to zero. In contrast, the amount of losses you can incur is unlimited because the price of an asset can climb to infinity.

This is where the benefits of AI become more valuable. AI technology has helped investors make automated trades with algorithmic trading.

There are a number of ways that you can streamline trading decisions with AI technology. You can create a number of different conditions to assist you. For example, you can specify that you want short positions to be closed when the stock drops to a certain value. This might cut into your earnings by causing you to close the position before it drops further and you can get more money. However, using AI to make this trading decision also limits the concern that you will miss opportunities to make a profit by closing the position before the stock can increase in value again.

AI also makes it easier to forecast the future value of assets by assessing many contributing variables. This can help investors identify stocks that are likely to drop in value, which can be profitable short-selling opportunities.

Ways to carry out short-selling

There are different ways to engage in short-selling. The most common method is what we’ve described above, known as “physical” short-selling, which entails borrowing assets, selling them, and purchasing the same amount of assets to return to the lender at an agreed date.

You can also open short positions through futures, forwards, or options, which entails assuming the obligation or a right to sell an asset for a fixed price at a future date. If the price of the asset falls below the agreed price at the future date, you can buy it at the lower price, sell it immediately, and pocket the positive difference.

Likewise, you can short assets using specific types of a swap, such as contracts for differences, which entails an agreement between two parties to pay each other the difference if the price of an asset increases or reduces.

A short sale is typically arranged through a broker and the short seller is usually required to post margin as collateral to ensure they can meet their liabilities, and to post additional margin if losses begin to accumulate.

Short-selling is a common practice in global markets. For example, in the US equity markets, it accounts for 40% of the dollar value traded, and in Australia, 13% of the dollar value traded.

Algorithmic trading for short-selling with AI Technology

Short-selling is usually achieved through the traditional way of market trading. But, there’s another way to do it, which is algorithmic trading which relies on AI algorithms. It refers to trading based on pre-programmed instructions accounting for critical variables such as timing, price, and volume. The goal of this type of trading is to leverage the higher speed and computational resources of computers relative to humans to earn better results.

Algorithmic and AI trading accounts for a great deal of market activity worldwide and is still growing. According to Mordor Intelligence, the market is expected to see a compound annual growth rate (CAGR) of 10.5% from 2022 to 2027.

You can apply AI trading to short-selling in search of profit. There is always a stock or any other asset that seems to differ from conventional pricing laws. For short-sellers, it’s a stock that’s priced way too high above market norms compared to its fundamentals. If you spot such a stock and have a high conviction concerning its value, you can build algorithms to take advantage of a possible price drop.

You can use algorithms to trade futures and options, which are common ways of short-selling. Let’s say, there’s a hypothetical company called Pills Inc whose business is developing and selling pharmaceutical therapies for rare ailments. This company is in the Phase 3 trial process of a new drug, the most important part of drug efficacy trials, but is yet to conclude and release the results.

As a short-seller, with some scientific background, you’re convinced that Pills Inc’s new treatment wouldn’t yield positive outcomes, so you expect the company’s stock to drop sharply once it releases its trial results. You can build algorithms to buy futures contracts at different price points you expect Pills Inc’s stock to fall to. If the stock eventually falls, you’ll profit from the futures contracts.

The good thing about algorithmic trading is that it’s automated, so you don’t need to stress yourself trying to find people willing to sell futures contracts to you or haggle prices when you eventually find them. Just write computer programs to automatically buy anyone that fits your price range, and you’re good to go.

You can also take advantage of timing and volume when trading futures, options, forwards, or any other derivative as a method of short-selling. For instance, you can write computer programs to buy futures contracts of Pills Inc if the company’s trading volume falls to a specific low level.

Algorithmic trading short-selling solutions

One of the critical aspects of AI short-selling is the platform you decide to use. Many automated trading platforms support short-selling, but we prefer MQL5.community because of its large user base and excellent track record. Its users have access to over 17 years worth of data and trading strategies built and maintained by the community, which is unparalleled compared to most competitors.

MQL5.com is an online community of algorithmic traders around the globe and it works in conjunction with the MetaTrader 5 trading platform. The community offers numerous features, including real-time market data, live chat, a forum, and about a thousand ready-made short-selling algorithms and articles each.

If you aren’t well-versed in computer programming and other requirements to build functional short-selling algorithms, don’t fret. One of the things about MQL5.community is that you can purchase algorithms built by professionals using the native MQL5 programming language and execute them with your capital. The MQL5 language’s structure is similar to C++, giving it a greater execution speed than most other languages.

On the other hand, if you’re already a professional in building short-selling algorithms, you can offer them to other users of MQL5.community for a fee through the freelance marketplace. The platform also gives valuable annual awards to the best-performing freelance developers.

Having accurate, real-time market data is necessary for every trader to be able to move with the market almost “live” instead of playing catch up, and MQL5.community helps you do that. It provides extensive signals and technical indicators about the global markets, which help you decide the best time to short assets.

You can also access a vast library of articles written by professionals on various topics, including short-selling, through this platform. Here’s a sample article about how to understand market patterns and apply them to automated trading.

MQL5.community allows live chat between users, which is beneficial, as short-selling often involves communication between traders around the globe. The chat feature is very secure (with the HTTPS encryption protocol), allowing traders to discuss issues that they can’t talk about in public. It also lets you broadcast messages using groups or channels, keeping the content secure for future reference and compliance purposes.

Lastly, there’s an official forum where MQL5.community users can participate in discussion threads, e.g., on calculating real-time short interest. One of the main benefits of this forum is that you can find traders willing to lend you assets for short-selling by opening a discussion thread. Afterward, you can negotiate using the secure live chat feature.

AI Technology Opens New Doors for Investors Using Short-Selling

AI technology has undoubtedly changed the future of finance. One of the biggest benefits is that it has led to the popularity of algorithmic trading.

Algorithmic trading is a massive industry worth $13 billion as of 2021, according to research from IMARC Group, and yet still growing rapidly. You can apply it in many areas of the financial sector, including short-selling, as we have demonstrated.

No one wants to get left out of great opportunities. Hence, if you’re up to the task, the algorithmic trading sector has a lot of room for growth that you can join. This is one of the best chances to take advantage of the power of AI as an investor.

I’m a young freelance writer specializing in psychology, education, technology and business. Currently I offer my help at Edubirdie.com as a content writer. I have many other interests and enjoy sharing them through my written words. I have a B.A. from New York University. Please follow my twitter @SteinmanAngela to know about my recently published posts.