Short Selling – Spread Betting
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I’m not quite sure why, but it always seems more satisfying to make money from shorting a share (profiting from it going down). Maybe it’s because it doesn’t feel conventional. With shares doing so well at the moment and some looking overbought, I feel that now is the time to open up at least a couple of shorts.
Of course, a bubble burst would cause ‘buy and hold’ investors a lot of headaches and financial pain. But to empowered spread traders like you it is just another spread trading opportunity. Short-term spread traders don’t care if the market is moving up or down – as long as it is moving!
Short-selling (profiting from a fall in a share) is an essential part of any spread trader’s weaponry, and these days it’s really no more difficult than “normal” buying of shares, thanks to spread betting. Let’s look at the mechanics of short selling and how you can make great profits from falling markets – first let’s start with the basics. If you’re “long” XYZ Company, it means you have bought their shares (either through a normal broker or a spread betting company). You will profit if the shares rise. I’m sure this is a situation familiar to all of you but let’s just walk through a quick example. XYZ are 100p per share and spread trader A decides to buy 1,000 shares. This costs him £1,000 (100p per share x 1,000 bought – I am ignoring commissions and stamp duty to keep it simple). Two months later, XYZ Company is 150p per share. Spread trader A decides to sell. He receives £1,500 (150p per share x 1,000 sold). His profit on the trade is £500 – the shares rose 50% and he made 50% on the amount invested.
When shorting getting the timing right can be a challenge so it would be a good idea to keep size positions small or have a basket of shorts as opposed to one big position so that you won’t be caught by surprise if positive news comes up. Shares that have been under pressure for a long time may also rebound sharply on the slightest bit of good news.
What’s the best way to short? There are three main ways: CFDs, spread betting and covered warrants. All three methods have their good and bad points.
CFDs boast very tight spreads and low commissions, though profits (if big enough) are subject to Capital Gains Tax.
Covered Warrants are excellent in that you cannot lose more than you put in. Again, gains are subject to tax.
Spread betting gains are not taxed, but of course you pay in wider spreads. However, you do get guaranteed stop losses, which can limit any downside.
My favoured method of shorting is spread betting, although I am looking at using CFDs within my pension plan for shorting purposes. But how do you find something to short? Well I guess, for me, it’s a reversal of how I look for something to buy. Instead of looking for positive statements, I am looking for the negative. I want a profits warning or a sector that is in the dumps.
For example, I opened two shorts recently and both are already in a nice profit despite the rising market. One was Provident Financial (I shorted at 675p). As soon as the company issued a profits warning, it interested me. Why? Because profits warnings, like buses, have a habit of coming in threes, and I see no reason why another one shouldn’t be on the way. Another was Holidaybreak, which shorted at 605p. Two reasons for this: firstly, the sector it’s in (camping and mobile-home holidays) is not exactly hot. Secondly, the recent statement was littered with the word “satisfactory”.
As far as I am concerned, “satisfactory” means “we’re kind of doing OK but nowhere near as well as we want to”. So, after having a good look at recent announcements from both companies, I am happy to be short.
I have a guaranteed stop loss with both, so I’d get stopped out if there are sudden rises. Why the stop? Because, occasionally, when companies show a weakness, a predator can step in and there can be an unexpected bid. That would see a share price shoot up and I would not want to get caught out.
Of course there are potential hazards in shorting, as there are with buying a share.
- Suppose you sold MBNA UK short at 675p because you thought it was performing poorly and that its results would be dismal.
- But just before the results were due the banking group HSBC put in a bid for MBNA UK, and the shares rocketed to 720p.
- Your judgement was wrong and now you have to cover your short bet by buying the MBNA UK trade back.
- There are no set limits on to how high a company’s share price can rise, so your ultimate exposure is unlimited as well.
The risk of takeover is always a scare tactic used by people who discourage short selling and while this is true there are two points a short seller has to realise -:
- Surprise takeovers happen very rarely.
- What about profits warnings where share prices often drop by 25% or more in a flash. There are in our opinion just as many potential risks to the buyer of shares as there are to the short seller.
Most short trades are commonly only held for a period of days or weeks compared to months owning a stock where you have a long position. When looking for short candidates I simply do the opposite to what I do when going long. So, AIM market is riskier than the main market – I’m looking at AIM stocks… High debt is better than cash rich. A trading loss is better than even a small profit. Crap/unproven management desirable. History of no earnings growth over the past few years. Share price has been ramped by tipster or bulletin board on a hopes and dreams basis. Points to ignore are assets (usually vastly overstated) and miners JORC (miners mineral value belongs to the state until they are out of the ground). Overvalued main market listed companies are few and far between but on AIM there are bucket loads.
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