Short sellers take profit after an earnings crash—such as Cloudflare's (NET) 22%+ plunge—to lock in their gains. This is because a short seller’s profit is the difference between the price at which they borrowed and sold the shares and the lower price at which they buy them back.
Traders close out these positions following massive drops for a few key reasons:
- Realizing Maximum Gains: Short sellers only make money when the stock falls. Once a stock plummets by 22% or more, a significant portion of the anticipated downside has already materialized.
- Avoiding Reversals: Short selling carries unlimited risk if a stock suddenly bounces back. Sharp drops often attract institutional "buy-the-dip" investors or short-squeezes, prompting short sellers to cash out before the price recovers.
- The Mechanics of Shorting: To formally lock in profits, a short seller must mathematically purchase the equivalent number of shares on the open market to return to their broker. This massive wave of buying itself frequently acts as a stabilizing floor for the stock, making it an ideal time for a short seller to exit.
To learn more about the mechanics of profiting from declining shares, you can review the Investopedia Guide to Short Selling or the Schwab Short Selling Overview.
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