How to make short selling an integral part of your investment strategy
What is short selling?
Most people think about trading in just one direction. They imagine buying an asset ('going long') before the price begins to rise. Then they imagine selling it just as it reaches its peak to reap a profit.
But it is also possible to profit from a falling market. Short selling can be a great way to capitalise on these market movements.
Short selling is the practice of selling an asset you don’t actually own, in the hope the price will decline so you can buy it back at a lower level. You then keep the difference between the price at which you sold the asset and the lower price you bought it back at.
‘Contracts for difference’ – or CFDs – give you an easy way to sell short. With CFDs, you trade the price of an asset rather than the asset itself, meaning there’s no need to borrow shares and buy them back. If the price of an asset like Apple shares fall, the value of the CFD falls in line with it, because it precisely mirrors the price of the underlying asset.
The net effect for the trader is the same, with the added bonus that CFDs allow you to easily short assets like shares, indices, commodities, forex, bitcoin and more. However, due to gearing the amount that you could lose relative to your initial investment is greater than for conventional share trading.
Take a look at two trade examples below – one making a profit, and one making a loss.
Profit-making trade
Let’s say that Macquarie is currently trading at A$21.24 per share. You decide to short sell 1000 shares of Macquarie for a total of A$21,240 (1000 shares x A$21.24 per share).
Shortly afterwards, the share price of Macquarie falls to A$20.74. You can now buy 1000 shares of Macquarie for A$20,740.
You then return the shares to the lender, who accepts the return of the same number of shares as they lent, irrespective of the fact that the market value of the shares has decreased.
You retain the A$500 difference (minus borrowing fees/commission) between the price at which you sold the borrowed shares and the lower price at which you bought them back.
Loss-making trade
Let’s say that Rio Tinto is trading in the market at A$1.50. You decide to short sell 2000 Rio Tinto shares for A$3000 (2000 shares x A$1.50 per share).
Shortly afterwards, the price of Rio Tinto rises to A$1.65. You need to close out to meet your obligation to the lender by returning the same number of shares.
You buy 2000 shares of Rio Tinto for A$3300 (2000 x A$1.65). Your broker then returns these to the lender, who accepts the same quantity of shares.
You've made a loss of A$300 (excluding borrowing fees/commission), which is the difference between the price at which you sold the shares and the higher price at which you bought them back.
Find out more about short selling through CFDs.
Short selling and hedging can go hand in hand. Find out more about hedging.
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1 Based on revenue excluding FX (published half yearly financial statements, June 2020)
2 By primary relationships, Investment Trends August 2018 CFD Report & December 2017 FX Report.
3 IG Group Holdings Plc, as at 31 May 2014.
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