The concept of short selling is one of the biggest benefits that CFDs bring to the table for a retail trader. CFD short selling gives retail traders like us the ability to trade in a similar fashion to intuitions, and hedge fund traders that previously were not available.
Short Selling is the opposite of buying stock. When buying, we profit by selling at a higher price. Short selling involves borrowing and selling stock we do not own in order to profit by buying back at a lower price. It’s a strategy that can be used as a hedge or to capitalize during a bear market.
To go short is simply the opposite of traditional going long. To open a position you sell then to close it you buy back. The idea behind short selling is to profit from falling markets. If you feel the price of an instrument will fall you will open a short position. Again in comparison to tradition share trading to profit from short selling we need to sell high and buy back low. Due to the short selling ban and restrictions placed by market regulators your provider will borrow stock from the market for you to short sell making the system flawless for you. Keep in mind these restrictions on short selling means that not all stocks are shortable, unfortunately, on the ASX its usually limited to the most liquid stocks. Around the top 200-400 mark. Some providers, upon request, will try and seek out stock for you if possible.
There are many reason why a trader short sells on a day to day basis. A lot of people speculate on markets. Markets can fall a lot faster than they rise. Certain Technical analysts that follow systems such as breakout trading need short selling when the price breaks a support line. Fundamental analysts may use short selling for potential bad market announcements such as declines in profit etc.
When done properly, short selling carries no greater risk than buying stock. Profits will often be realized quicker because stocks tend to fall faster than they rise as the emotion of fear is stronger than greed.
The ideal short sale begins with the right stock selection and the correct set-up. I often look for a liquid, volatile stock that has formed a good top after a large, quick advance and is attempting to break support. The on-balance volume must be falling, showing the sellers in control. It’s then a matter of identifying a point of entry that allows me to sell short at stop on the break of support while simultaneously placing a tight protective buy stop order to automatically cover my position in case the stock does not dump as planned. As the trade unfolds, I trail the buy stop to breakeven and below to lock in profits while staying with the downtrend.
More importantly a lot of CFD traders use short selling to hedge current portfolios. Many of in may be personal portfolios, Self Managed Super Funds or trusts. By taking an equal and opposite position in you CFD account you can perfectly hedge an investment portfolio.
Why would an institution ever lend me shares for shorting them?
Loaning out shares to those who want to short is legitimate. A fund management company like Blackrock will do it because they believe in the company they are invested in and think the share price can withstand some shorting – they make some additional money for their investors by loaning out the stock and assume that at worst it’s likely to be a zero sum game – if the shorters manage to drive the price down then it will recover when they close because it is a quality company with good prospects.
Trading Tip: Avoid the stock everyone else agrees must crash. Be a contrarian.