Selling Short
22/11/2013 11:37
Selling short is a market transaction technique commonly used to profit from the falling price of stock shares. It is accomplished by a broker allowing transactions under terms of a Contract for Difference, or CFD. Proceeds of the sale are held by an investor's stock broker until borrowed shares are returned after investors close their positions by buying shares in the market place. The profit or loss for the trade is then credited to or debited from the investor's trading account. The trader will profit if the price falls, but will lose money if the value rises. Even though this strategy can be used by disreputable traders to drive down stock prices, CFDs are allowed on many national exchanges.
Most markets either restrict or prevent selling short. Restrictions are usually placed on when and how a short sale can occur, and “naked shorting” is illegal on most exchanges. In selling short, investors can take advantage of an overvalued stock during a rising market trend. For instance, a short sale strategy can be used to reap unsubstantiated benefits in a “bull market,” which may increase the value of even marginally performing stocks. Market trends may occur, but performance predictions can result from sheer speculation rather than empirical calculations.
A “bear market” describes a general downward movement over a continuous two-year period. Profiting from a downward move on a stock is referred to as a “short position.” A short position refers to the practice of selling borrowed stocks with the intention of buying them back at a lower priceand returning the stocks to the lending party. Investors place stop-loss orders with their brokers to protect themselves from loss, if the stock should fall. The stop-loss order tells the investor's broker to sell the stock when the stock falls to a certain price.
Across time, the investor who exercises both an effective long trading system and an effective short trading system can profit whether the market is bullish or bearish. In a bull market, the long trading system is likely to perform well, and in a bear market the short trading system has a better chance to profit. When choosing stocks to trade, the investor may want to identify those that embody weak business foundations, those that may be adversely affected by negative rumors or public opinion, and those that are said to be “up and coming.” The interplay between the temperament of the market and the potential staying power of the stock will determine the best trading position to take.
Short selling a stock can be done in several ways. A trader can short-sell the share itself or sell CFDs greater than a share. A trader can buy “put” options or sell “call” options greater than a share, or buy put warrants greater than a share. When investors open a short position, they make money if the share price decreases and they lose money if the share price increases. A market order instructs an investor's broker to sell immediately at the best possible price.
By selling large quantities of shares of targeted companies, speculators influence the price of shares to go down. Selling short can force share prices to fall below what is justifiable, thereby destroying market and public confidence in the company and possibly leading to the company’s facing financial collapse.