Shorting / Short Selling Guide

Short Selling
Short it out!

What is Short Selling?

Short Selling, aka Shorting, aka “taking a short position”, is when you speculate on a market e.g. a company, or a commodity, to fall in value.

Shorting lets you make a profit in a falling market.

Below is useful 2m:30s introductory video on short selling.

How Can I Short A Market?

The easiest way to short a market is normally with financial spread betting or CFDs.

With a spread bet, or a CFD, you simply put a sell trade on the market you want to short.

All spread betting companies let you short the markets.

Important Short Selling Warning

Whether you speculate on a market to go up or down, trading is rarely straight-forward.

When You Can’t Short a Market

Occasionally there is a misguided ban by a regulator on short-selling (see below for more details on the ill-judged 2009 ban).

Luckily, these kinds of ban are few and far between.

More commonly, there are often restrictions on shorting newly listed shares.

This is because it’s difficult for the spread betting and CFD firms to offload any nasty short positions they accrue.

E.g. you might have wanted to short the Twitter, Alibaba, Facebook or Snap stock when they IPO’d.

If so, your initial instincts would have been correct.

However, the spreads firms were only taking buy trades and closing trades but not sell trades. Sadly, you couldn’t put on a new sell trade on Snap.

Practicing Shorting Selling

It’s easy to practice selling the markets with a free demo account.

Remember that “easy to practice” is very different to “easy to profit from when trading with real money”.

What Markets Can I Short?

Again, you can short most large markets e.g.:

What Markets Can’t I Short?

If a company is private, e.g. a unicorn, then it’s difficult to short the stock. You’d need to find the investors and do a deal with them. This is unrealistic in 99.9% of cases.

Small public companies e.g. AIM listed stocks, can be difficult to short because most spreads/CFD brokers either don’t offer those companies or the prices have prohibitively wide spreads.

As mentioned above, newly listed stocks can be difficult to short.

Shorting Forex Markets

A forex market e.g. GBP/USD is based on the relative value of one currency versus another.

With GBP/USD if you thought the pound would weaken against the dollar, then you might want to short the pound.

If so, you would simply sell the GBP/USD market.

E.g. GBP/USD was trading at $1.71 before the UK Brexit referendum. After UK voted to leave the EU, many traders thought the pound would weaken and so shorted the market.

The traders correctly shorting the market would have made a profit as the market fell all the way to $1.20.

I say “correctly” because there were plenty of bounces on the way that could have caught traders out.

If you wanted to short the dollar vs the pound, e.g. perhaps you thought that Donald Trump’s endless nonsense would hurt the US currency, then you would actually “buy” the GBP/USD market.

Short Selling Example

Short Selling Example

Imagine the FTSE 100 is trading at 7,000 – 7,001 and you think the index is going to drop.

Therefore you could place a short (sell) spread bet of £10 per point at 7,000.

Then, over the next week, the FTSE falls to 6,950 – 6,951, and you close your trade 6,951.

This would be a healthy 49 point profit. With a £10 / point stake your profit = 49 points x £10 / point = £490 tax-free profit†.

Of course, if the UK index rose, you might be nursing a painful loss.

If the market moved up to 7,052 – 7,053 then you might decide to close your trade to stop any further losses.

If so, you’d lose 53 points x £10 / point = £530 loss.

For fully worked examples see:

The 2009 UK Short Selling Ban

In mid-January 2009 the UK’s Financial Services Authority (the FCA’s predecessor) finally lifted the ban on short selling UK financial stocks.

Essentially the ban stopped investors from shorting 19 UK financial stocks e.g. Barclays, HSBC, RBS etc.

So whether you liked to spread bet and/or trade CFDs you were not allowed to bet on these financial stocks to go down. Of course, you were still allowed to bet on them going up.

That would not have been a great investment decision, at least not in the short term.

Banking stocks had been leading the declines in the months prior to the ban. Should their share prices continue to fall then no doubt it would still be blamed on the short sellers once again.

There is still no evidence that short selling before the ban was the main reason why bank stocks suffered such terrible falls.

Given that the sector fell over 55% after the ban was introduced maybe people will understand that it is not just the “spivs and speculators” driving prices down.

It is the fundamentals.

The many investors who held onto bank shares in the months before the short selling ban will probably have been quite annoyed that there was a ban.

Without the restriction they would have been able to hedge their exposure by selling short, whilst continuing to hold onto their underlying investment.

Sadly for them they saw an outright depletion in their investment.

Stock holders may still have been able to short if they had a “Net Flat” or “Net Positive” position, there does not seem to have been complete clarification of this point.

Overall, the ban caused confusion for traders, at the same time it also prevented them from making a legitimate investment decisions.

Did we expect to see increased selling after the lifting of the ban? Perhaps not. Simon Denham of Financial Spreads said at the time, “The lifting of the ban is not expected to have any incremental effect on our business since we saw so few clients shorting financial stocks previously.

“So should we take advantage and start selling the stocks again? I am not so sure. The stocks have had some massive falls.

“The shares may indeed fall further but the risk may not be worthwhile. If the black holes in the balance sheets start to shrink and the ‘unknowns’ become ‘knowns’ then the shares could quickly recover.

“For now it may be better to look at the companies that are reliant on the banks for credit.

“The heavily indebted companies, particularly those that need refinancing in the next 3 months could find themselves in a spot of bother.”

AuthorAlex Turner

Senior Editor, SpreadBetMagazine

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