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With the COVID-19 pandemic sending stock prices plunging across global markets, it's worth understanding how advanced traders can continue to profit by short selling stocks and indices like the S&P/ASX200.
Short selling historically gets a bad rap in the investment world because traders are benefiting from a company's loss. However, the strategy can also be used to offset your own losses during a stock market crash. This can be particularly useful for investors holding a portfolio of dividend shares that they'd prefer not to sell as prices fall.
While it varies from country to country, there are a few different ways to short sell stocks, from borrowing shares from a broker to trading put options and CFDs. We'll give you an overview of what short selling means, how you can do it and the risks involved.
Important: Short selling is a controversial strategy and not everyone thinks it should be allowed. Some countries have banned it entirely. Either way you look at it, short selling is for experienced traders only.
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The idea behind this investment strategy is that if you think a stock's value is going to decrease, you can make money out of it. You borrow the stock from a broker, sell it at the market price, buy it back when the price has decreased, then give the stock back to its legitimate owner and keep the profit.
A quick example: Say you think CSL's stock price is going to fall today. You borrow 10 CSL shares that cost $200 each and sell them at market price ($200 x 10 = $2,000). It turns out that you're right and by the end of the day, they're worth $180 each. So you buy them back for less than you sold them ($180 x 10 = $1,800), then give them back to the broker. You keep the profit, which is $2,000 - $1,800 = $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, 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 $210 instead ($210 x 10 = $2,100), you'll lose money ($2,000 - $2,100 = -$100).
The traditional means of shorting a stock directly is to contact a full-service broker or a major investment fund such as Morgan Stanley. 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, those that are either professional investors or are investing a minimum of around $500,000.
However, it pays to be aware that since the GFC, the Australian Securities and Investment's Commission (ASIC) has clamped down heavily on short selling, so many brokers no longer offer it as a service. Below is the traditional method for shorting a stock:
The most shorted stocks on the ASX
Many traders prefer to short sell through online share trading platforms. In Australia there are two key ways to do this:
Repeat after us: short selling is for expert investors and you shouldn't do it unless you do know what you're doing.
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" instead, 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.
Important: Share trading can be financially risky and the value of your investment can go down as well as up. “Standard brokerage” fee is the cost to trade $1,000 or less of ASX-listed shares and ETFs without any qualifications or special eligibility. If ASX shares aren’t available, the fee shown is for US shares. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
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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