Short selling is a trading method that seeks to profit from an expected drop in the price of a certain share or stock. When you short a stock, you're betting that its price will decline in future.
Traditionally, this requires borrowing a certain number of shares from a current shareholder and then repaying them at a later point. If the price of the stock is lower than when you originally borrowed it, you make a profit.
However, this form of short selling is normally only available to institutional investors, but there's a still a number of ways that retail investors can short a stock using a regular share trading platform.
The most straightforward way for Australian investors to short a stock is by using CFDs (contracts for difference) or options.
Both CFDs and options let you speculate on the future price of a stock, meaning you can place a trade that will profit off the price going down.
Shorting via CFDs
CFDs are derivative investment products that allow you to speculate on prices without actually owning the underlying asset.
This means that CFD traders can profit whether the prices of stocks, commodities or currencies are going up or down.
Be aware that CFDs are complex, risky financial instruments and many investors lose money this way.
Shorting via options
You can take out a short position on a stock by using what's known as a "put" option.
Put options give you the opportunity to sell a specified amount of stock at a set price (known as the strike price) within a certain time frame.
If the price goes down, you sell the stock and then buy it back at the new price to make a profit.
If the price goes up, you don't sell the stock at all and only lose the value of the option, thus limiting the risk.
With traditional short selling, you can buy back whenever you want (unless the owner of the stock claims it back), whereas options normally have a fairly short expiry date.
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When you enter a trade, you are either "long" or "short".
A short position refers to someone that looks to profit while the price of an asset is falling, while a long position seeks to profit on assets that are rising.
(When you buy a stock, you're technically taking a long position as you're expecting the price to go up over time.)
If you enter a short position or short sell, you borrow the stock from a broker, sell it at the market price and then buy it back when the price has decreased. You then give the stock back to its legitimate owner and keep the profit.
The plan is to sell the stock when the price is higher and "buy" it back when the price is lower, profiting the difference.
Say you think CSL's stock price is going to fall today.
You borrow 10 CSL shares that cost $300 each and sell them at the market price ($300 x 10 = $3,000).
It turns out that you're right, and by the end of the day, they're worth $280 each.
So you buy them back for less than you sold them ($280 x 10 = $2,800) and then give them back to the broker.
You keep the profit, which is $3,000 - $2,800 = $200.
Even after the fee that you'll have to pay to the broker for the stocks you borrowed, it's a nice earning.
It sounds easy, but the problem is that things could also go the other way around.
If it turns out that you were wrong, and at the end of the day, 1 CSL share is worth $310 instead ($310 x 10 = $3,100), you'll lose $100 instead ($3,000 - $3,100 = -$100).
The Australian Securities and Investments Commission (ASIC) releases daily reports that detail the current short positions against companies on the Australian Securities Exchange (ASX).2
According to ASIC, these are the 5 most shorted companies on the ASX based on the percentage of the total share count that is currently being shorted:
Pilbara Minerals Ltd (ASX: PLS) - 20.31%
Idp Education Ltd (ASX: IEL) - 14.33%
Syrah Resources Ltd (ASX: SYR) 12.33%
Paladin Energy Ltd (ASX: PDN) - 11.44%
Mineral Resources Ltd (ASX: MIN) - 11.38%
This list was last updated on 24 September 2024.
The entire purpose of shorting a share is because you believe the company (or the market as a whole) is currently overvalued.
This could be for a number of reasons, like the company experiencing difficulties, the industry or sector it operates in being likely to contract or simply believing that it doesn't justify its current share price.
You might also be shorting a stock because you think the market as a whole is overvalued.
If the market has had a prolonged bull run and the market appears to be heading towards a recession, it could be a sign that share prices are likely to fall.
Finally, you might simply think market sentiment around the stock is weak in the short-term and are looking to profit off any potential sell-off.
"If you're looking to try short selling, you might want to consider using a demo account to practice before committing real money. Platforms like eToro and Tiger Brokers offer free demo accounts that you can use to refine your strategy."
In order for short sellers to exist, there needs to be someone willing to loan the shares out.
As such, you might be thinking why would they want short sellers to bet against businesses that they own? It's because they get money to loan out the shares.
Let's go again with our CSL example, but this time let's say you're bullish on CSL and want to hold the company for a decade.
If you like the company and want to earn some additional income off the shares, you can lend them to short sellers. These short sellers would have to pay you for the right to bet against them.
Now your own paper wealth would change if the price of the shares fell. But if you have no intention of selling, it doesn't materially change your circumstances.
Secondly, the shorters aren't necessarily correct. They simply have a different take on a business's fundamentals than you do at a particular time.
So if you think the company is undervalued even as shorters say it's overvalued, then you can effectively cash in on them disagreeing with your opinion.
Better still, even if a company is on the high end of your valuation, that doesn't necessarily mean the share price will fall.
The traditional means of shorting a stock directly is to contact a full-service broker or a major investment fund. Full-service brokers usually offer advice alongside trading and they charge a premium price for the service.
In Australia, the service is usually only available to wholesale investors, professional investors or people investing a minimum of around $500,000.
However, it pays to be aware that since the GFC, ASIC has clamped down heavily on short selling, so many brokers no longer offer it as a service.
This is how traditional short selling normally works:
Repeat after us: short selling is for expert investors and you shouldn't do it unless you know what you're doing.
The majority of most retail investors lose money when trading CFDs (including shorting), according to multiple ASIC reviews.1
The reason it's considered so risky is that you could lose "infinite" money. When you buy a share and "go long", the maximum you can lose is the amount you invested.
When you "go short", there are no theoretical limits to how much share prices could go up, and thus to how much you could lose.
It's especially dangerous if a lot of people are short selling shares from the same company and the price unexpectedly goes up. At that point, everyone will start buying back quickly, causing the stock to go up even more.
It's what's called a "short squeeze" and it easily becomes a vicious cycle that turns out very expensive for short sellers.
Finally, don't forget that short selling isn't free. Brokers will charge a fee for lending stocks, and there are fees for other short-selling methods too. Be aware that these will partially lower your gains and increase your losses.
Say you hold a portfolio of stocks and you predict that a market crash is coming or a company's stock is going to fall. To avoid losses to your portfolio, one option would be to sell the stocks of the companies that you hold before their prices drop – if you can get the timing right.
However, if you hold dividend stocks, you might prefer to keep them for the long run for the income. To avoid your portfolio falling in value (without selling the shares), you could short the stocks through a CFD or put options to the amount you think they will fall – and so offset any losses.
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
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Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
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