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Short-selling enables traders to profit in a down market or protect existing investments. Find out how and why short-selling can become a key part of a balanced trading strategy.
There are three key sets of participants in the short-selling market:
Individuals short-sell through a broker to hedge the risk of loss on other positions, or to speculate that a market’s price is going to fall.
These tend to possess a large investment pool, allowing them to take on the risk of short-selling as part of their trading strategy.
Short-selling is an important tool for hedge fund managers – in fact, it’s what puts the ‘hedge’ in hedge fund.
Short-selling is only possible when there’s a stockholder in the marketplace who is willing to lend the stock they own. But why would a stockholder want to do this?
The reason is that stockholders can charge a borrowing fee for lending their stock, which the broker will pass on to the client. Pension or superannuation funds, for example, are a major lender of stock in the market, as this allows them to make additional income from their long-term investments. The argument for lending in this way is that it allows for a more liquid market.
If, however, lending and short-selling leads to an overly bearish view that pushes the share prices lower, lenders may quite rationally withhold their stock. Stock becomes unborrowable when no one in the market wants to lend.