SHORT SELLING STOCKS

WHAT IS SHORT SELLING AND WHY DO IT？

Short selling is the process of borrowing shares via a broker, selling those shares at the current market price and later buying the shares back at a lower price in order to return the shares to the broker.

Why short stocks？ The answer to this question is multi-layered but in general, shorting stocks presents an opportunity trade a decline in a shares price.

To some, short selling seems rather unethical because you are essentially taking a stance that a companys share price will fall, which could result in large scale retrenchments affecting many households in the process. To others, this represents an opportunity to speculate in on over-valued stocks or to benefit from the largescale selling of unscrupulous companies.

Nowadays, in addition to retail traders, there are well-established hedge funds that focus on short selling, or ‘shorting’ various companies. Some short sellers publish research on companies that are alleged to have reported misleading figures in the publication of financial statements or where there is sufficient evidence of corrupt business practices.

KEY TAKEAWAYS

Shorting a stock has been made a lot easier with the advancements in technology and forms a part of a traders skillset. However, unlike the forex market, stock traders are faced with the unique problem of unborrowable stocks that prohibit any shorting of stocks. Traders should only consider initiating a short trade after conducting the necessary technical and/or fundamental analysis while adhering to sound risk management practices.

As a reminder, the top 5 takeaways for shorting a stock are:

• Use a regulated broker: Consider using a highly regulated, reputable broker when short selling stocks.

• Trend: In the absence of a well-established downtrend, traders should set entry orders at favourable levels in the event the market gets there. Shares have the potential to trading gap down – especially if negative information finds its way into the public domain. In such fast-moving markets, traders can miss a favourable entry when away from the trading screen and orders can help.

• Liquidity/Borrow: Is the stock trading on a major exchange with a healthy number of shares changing hands daily, otherwise known as ‘free-float’？ Greater liquidity tends to translate into more borrow being made available to short sellers and greater flexibility to short the stock.

• Borrow charge: In addition to any overnight funding charges on open positions held overnight, there are often ‘borrow charges’ that apply to short positions to allow short sellers to participate in the market. It is always a good idea to enquire about such a charge with your broker before placing a trade.

• Risk Management: Since short trades theoretically have unlimited losses with limited gain (price can only drop to 0), traders need to make use of stops and limits to rectify an inherently skewed risk-reward payoff.

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