Get Shorting

Definition of Shorting Shares: – selling securities you do not own in the hope of buying them back at a lower price in the future and pocketing the difference.

Example

David thinks share in XYZ Plc are going to fall from their current price of 450p.

He enters a contract to sell them at 450p in three months time.

The price falls from 450p to 400p after three months.

He buys the shares at 400p making an 11% profit (450 – 400 = 50/450).

If his bet was for £10 per point, the profit would have been 50 x £10 = £500.

With shorting, the risk is that the price moves upwards during the time period of the bet.

In the example above if the price rose to 480p, David would have had to close his bet by buying at that price. His loss would have been 30 points (450 – 480) and, assuming that the bet was for £10 per point, he would be down £300.

 

In ordinary share trading, there has always been a psychological barrier to shorting. ‘Selling something you do not own’ was felt to be improper, almost unpatriotic, and somehow not in the spirit of investing.

If you buy a house on a Greenfield site from a property developer when all the company has at that time is a block of land and a building plan, the property developer is selling you a house that does not exist yet.

You should dismiss the thought that shorting is an unorthodox way of trading, or a kind of exotic activity reserved for hedge funds and sophisticated traders. It isn’t. It is simply the reverse side of going long, and a way to back your view that a price is likely to go down. This of it this way:

    – If you only ever go long on shares (buy before you sell), you can only make money from price advances.

    – If you have shorting in your armoury, you can profit from price falls as well.

As we all know, markets can fall as well as rise, so it makes sense to be as comfortable going short on the markets as you are going long.

In spread betting, shorting is equivalent to placing a sell on a market. The way you profit is exactly the same way as when you buy. If the price falls by 10 points then your profit is 10 points multiplied by your stake.

Example

David walks into a branch of a listed hardware company Hammer Co. and notices that there are less people lining up to buy items from the store than in previous weeks. David follows the shares of Hammer Co. and remembers that the company is due to release a trading update in a few weeks.

He predicts that Hammer Co. will lower their sales targets based on his research and what he witnessed at the branch. He places a down bet at £10 per point at 130 p.

As he rightly predicted, Hammer Co. announced weaker than expected sales over the latest quarter. The share price falls to 110p and David makes a gain of 20 points (130p – 110p) X £10 = £200.

Shorting is a useful tool but beware that short selling is not for the inexperienced. If you’re tempted into short trades due to a broad market sell-off, beware that they are not very rewarding for the time and effort. You can’t multi-bag a short trade. The downside is limited and a bounce quickly eats into profits. Shorting in this sense isn’t as easy as it looks unless you have a strict plan for entering and exiting with protective stops. Search the internet to look for short trade stock screening criteria and you won’t find any (or many). That says to me how difficult it is. If I were taking short trades I’d be waiting for the next market bounce so as to trade from a market high. If not you need diversity with low stakes and wide stops for lots of small profits rather than thinking of big profits from one or two trades. Even then you need the luck of a long protracted bear market. I’ve done plenty of long/short trading but it really does need total discipline. If the market keep falling all commodities including gold will go down as hedge funds and investment banks leverage to maintain balance sheets.

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