In most investment trading strategies, you make profits when the market moves up. Short selling is the opposite.
You make money when the value of the stock or other security declines. It is an advanced trading strategy experienced investors, and traders, use to make money from a company's misfortune.
In this blog, learn about what short selling is, who does it, how it works, the benefits and risks, the best brokers offering this service, and the steps to execute short-selling in Australia.
Buy Australian & international shares with unlimited commission-free trades. (No brokerage). Other fees may apply. It offers extensive trading features, social trading tools, and copy trading to imitate the trades of other famous traders.
1. What Is Short Selling?
Short selling is an investment strategy where you make money when the stock's value decreases. Large investment firms, hedge fund managers, institutional investors, and portfolio managers use it to hedge against the risks of a market recession.
The main objective of shorting a stock is speculating on overvalued companies, a shrinking sector, an overhyped business, a falling market, or companies with a prolonged share price run-up.
In the Short Selling strategy, the trader borrows the stock from a broker and sells it at the current market price. He repurchases the stock when its price decreases. The difference between the sell and buy price is the profit from the trade.
2. How Does Short-Selling Work?
You speculate that the stock price will decline, and with this belief, you borrow shares from a broker and sell them at the current market price.
After the stock price declines in your favour, you repurchase them and give the stocks back to the lender. As you don't own the shares, you must pay the broker interest on the borrowed amount of money.
The loan owing from the broker closes when you repurchase the borrowed shares. (Returning them back to the lender)
The difference between the selling price (when you borrow the shares from the broker and sell them) and the buy price (when you buy them back) is the short seller's profit.
Let's Understand The Concept Through a Stock Shorting Example:
The below short-selling example will help you understand how you profit from short-selling.
Here, you borrow 10 x shares of CSL company for $300 each. You sell them at the current market price ($300 x 10 = $3,000). By the end of the day, the stock price decreased to $280. This means the cost of 10 x CSL shares is now $2800.
You buy them at this price and make a profit of $3000 - $2800 - (stock borrowing costs, trade fees, and margin interest).
After deducting the cost from the profit, you still made a nice gain.
3. Why Do You Short Sell A Stock?
There are mainly two reasons that compel people to use this strategy to make gains in the market:
Shorting as a hedge, such as a long position.
Making money in the falling markets.
4. Steps To Short Sell A Stock In Australia on The ASX
You need to follow the below step-by-step process if you want to short a stock in Australia:
Step 1: Join A Trading Platform That Offers Short Selling
Do some research to find a broker that facilitates short selling.
The trading platform offers extensive trading features, social trading tools, and copy trading to imitate the trades of other famous traders.
Buy Australian & international shares with unlimited commission-free trades. (No brokerage). Other fees may apply.
Step 2: Find A Stock That You Wish To Sell Short
Ensure you have a margin account with the broker and permission to open a short position in a stock.
Step 3: Place Your Short Order For a Fair Number of Shares
The broker will lend you the desired number of shares and open a position to sell them on the market on your behalf. The shares borrowed are under a contractual lending arrangement.
Step 4: Track The Price of The Borrowed Stocks
You must follow the price of the stocks you have shorted to know when to repurchase them, either with a profit or loss. It is essential as you could incur high losses if you're not monitoring the stock price action.
Step 5: Close Your Short Position
When you think you have an excellent risk-to-reward balance, close the position.
To do this, you need to repurchase the stock you have initially sold and then return the borrowed shares to the person who has lent them to you through your broker.
The trading platform will facilitate all of this on the back end. Once you return the stocks, you have either made a profit or a loss.
5. How Do You Borrow Shares To Short Sell?
You can do it in two ways:
Taking advantage of the services of an investment fund.
6. Do You Need A Broker To Short A Stock?
Here is a list of brokers that allow short selling in Australia:
7. What Are The Disadvantages Of Shorting A Stock?
Short selling is the opposite of a traditional "long" strategy, where stock gains can be infinite, and the total loss is limited to the initial investment amount.
On the other hand, short-sell losses can be infinite as the price of any asset can rise to almost any point. The penalty for short selling is that your losses can be limitless. You can lose much more than your investment.
As there is no upper limit to how high a stock price can rise, you might need help to cover the losses.
If you incur massive losses, your broker could invoke a "margin call", where you are forced to close your short position unexpectedly by repurchasing the shares at the worst possible time. Your trade remains open until you buy back the original shares you borrowed.
Short selling may involve Regulatory Risks wherein Regulators occasionally impose bans on short sales in the broad market or in a specific sector to avoid fear and unnecessary selling pressure.
8. Comparison Of Online CFD And Options Brokers
|Broker||Min. Opening Deposit||Commission - ASX 200 Shares||Available Markets|
|eToro CFD||$0||Commission||Forex, Shares, Indices, Cryptocurrencies, Commodities, ETFs|
|Plus500 CFD||$200||No commission||CFD on Forex, Commodities, Cryptocurrency, Indices, Shares, Options, and ETFs|
|ThinkMarkets CFD||$0||$0 for the standard account||Forex, indices, commodities, metals, share CFDs, ETF CFDs, futures|
|IG CFD Broker||$0||0.08% with a $7 minimum||Indices, FX, Shares, Commodities, Cryptocurrency, ETPs, Options, Interest Rates, Bonds|
9. How Much Money Do You Need To Short A Stock?
To short a stock, you need capital. Short sellers have to open a margin account that enables them to borrow money from a broker using their funds as collateral.
Short sellers must meet the minimum maintenance requirement of 25%. You are subjected to a margin call when the account value slips below this. If this happens, the broker will ask you to add more capital or liquidate your short position.
10. How Profitable Is Short Selling?
Short selling enables traders to make money from a down market. Unlike traditional trading, where you "buy low – sell high," short selling puts the "sell" transaction first, opens a short position, purchases the shorted stock, and closes out the trade.
Short selling is profitable only when a trader makes the correct speculation and share prices go below the price he sold short. In that case, a trader makes a profit which is the difference between the stock’s buying and selling price.
Short-sellers put up a percentage of their total stock value with margin trading. They can make a decent return on investment with a smaller investment. When done carefully, short selling can be cost-effective to hedge long positions in your investment portfolio holdings.
Here are a few advantages that make short-selling profitable:
Little initial capital required
Potentially high profits
Hedge against other holdings to offer added risk protection for your portfolio.
11. What Is The Most Popular Way To Short The Market?
Short-sellers implement three main strategies to short the stock market. These are:
Short selling an ETF is another way to short the market. Here a trader takes a short position on an index ETF. When the index declines, a fund indexed to it falls, and your short position results in a profit.
Another way to short-sell the market is to take a “put” position on the index option or futures contract. When a trader buys a put option, he can (but is not obligated to) sell a security at the strike price any time before a specific date. So, whoever sold you the put option (the writer) will pay you the stick’s strike price at any point before its expiry.
12. How Long Should You Hold a Short Position?
An investor/trader should hold a short position for as long as they expect to profit from their investment. However, there are a few additional factors that they might need to consider to place a short-selling trade. These include:
The borrowing agreement terms and conditions include the interest amount the broker charges on the borrowed loan to your margin account. The longer you hold on to the short trade, the more interest charges you will accrue, which would lessen your net profit.
Existing market conditions
Your maximum acceptable loss also determines how long you will remain in the trade if the stock value increases rather than decreases.
If you want to hedge your existing long position, you may require holding on to the short position until you maintain an opposing long position or don’t see the possibility of considerable decline in the long position.
13. What Is The Fee For Short Selling?
In addition to trading commissions, there are other fees/expenses that you must pay to brokers when Short Selling a stock.
Stock borrowing costs
Margin Interest (when trading stocks on margin)
Dividends and other related payments. (The short seller must make dividend payments, including fees linked to corporate events like stock splits and spinoffs).
For example, the margin fee for an online broker is between 6.25 and 9 per cent, with a base rate of 7.75 per cent. It charges a stock commission fee of $9.99.
14. Why Is Short Selling Difficult?
Here are some of the potential cons of short-selling that make it difficult:
The shorted stock can rise to infinite levels, leading to unlimited losses.
You need to have a Margin account and fund it (with minimum maintenance requirements) until you hold the stocks.
Wrong timing can make you vulnerable to margin calls, margin interest, and being called away.
Short squeezes - when there is a sudden spike in the shorted-stock price, short-sellers are compelled to cover their short positions at heavy losses.
You must pay high short Margin interest on placing short trades using margin. This interest can add up over time, particularly when short positions are kept open over a long duration.
Short-selling involves substantial stock borrowing fees.
Short-selling may also involve regulatory risks where regulators may impose bans on short sales within a specific sector or in the broad market to avoid unjustified selling pressure.
Short-sellers must pay for events linked to the shorted stock to the entity from which they borrowed it. It includes dividends, share splits, bonus share issues, spinoffs, etc.
Considering the above risks, beginner investors should refrain from short selling until they gain more trading experience. Doing it through ETFs is relatively safer due to the lower possibilities of a short squeeze.
15. Frequently Asked Questions (FAQs)
What Are The Different Ways To Short A Stock?
The outcome of short selling depends on the method you choose.
Traditional Short-Selling: This method is via a broker. You borrow shares from someone who owns them and sells them at the current market price. When the share price declines, the investor repurchases them at a lower price and makes a profit from the difference in value.
Alternative Methods of Short-Selling Stocks Are:
When Do Traders Like To Short Stocks?
Trade during a Bear Market (when the market decline is swift, deep, and broad). Many experienced short sellers use multiple technical indicators to confirm the Bearish Trend.
When they see signs of economic slowdowns, such as opposing geopolitical developments, like the possibilities of war is an excellent time to short-sell.
When they see indications that challenge a business, like increasing costs putting pressure on margins and slow revenue or profit growth.
When the stock market approaches new highs or valuations reaches "Elevated Levels."
Is Short Selling Allowed On ASX?
Short selling on ASIC is allowed as it brings price efficiency and provides liquidity into the market.
However, in 2008, ASIC placed strict measures on "naked short selling" and "covered short selling" to bring order to the market turmoil. It has resulted in reduced liquidity and volatility in the market.
A limited number of ASX companies are permitted to be sold short. Click here to find the list of approved companies, along with the collateral requirements.
Is Short Selling Legal In Australia?
Short selling is legal in Australia, provided short sellers comply with the corporation's laws and regulations. In other words, short sellers who communicate fake information are prohibited from short-selling in Australia.
Does Commsec Allow Short Selling?
How Can You Short Stocks on eToro?
If you have enough money to trade with your margin account, follow the below steps to short-sell via the eToro platform.
Open an account with eToro
Place an order to short sell order of your choice.
Fund your trading account with the minimum balance to short-sell a stock within an eToro margin account. It covers your losses if your short sale goes against your speculation.
Who Are The Most Famous Short Sellers Worldwide?
Here is the list of the most successful short sellers of all time:
What Apps Lets You Short Stocks in Australia?
Once you understand how to short-sell a stock, you will need an app.
eToro CFD App (With over 5 million users, it is the largest ASIC-regulated trading platform in the world. The app is ideal for those who need more time.)
You can crate an account with eToro here.
CMC Short Selling App
Saxo Capital Markets CFD App
Go Markets CFD App
IG CFD App
ThinkMarkets CFD App
AvaTrade CFD App
Capital.com CFD App
Plus500 CFD App
How Do You Tell If A Stock Is Heavily Shorted?
The level of short interest in each ASX stock determines how bearish the stock is. It is published for each stock on the ASX website.
A stock with a high short interest (double-digit number between 12 to 15) is ideal for short-selling.
It indicates that many people are betting against it, and there are higher chances for the stock price to rise at any instant. You will also see high short-term volatility in such stocks.
How Long Does A Short Squeeze Usually Last?
There is no “standard” duration for a short squeeze, as each shorted stock has a distinct level of short interest and a short interest ratio. Usually, short squeezes last between several days and several months.
How Much Can A Stock Go Up in a Short Squeeze?
You can’t estimate how much losses you may incur on a short sale. As there is no ceiling on the upside movement of the stock, there is no limit on how high a stock can go.
What Happens If You Short a Stock and it Goes up?
A short seller can have "virtually unlimited risk" given that the stock price can increase to infinitely higher prices. It implies you cannot cap your losses if the shorted stock rises.
It is the main reason short selling is highly risky than traditional trading for retail investors.
Who Buys Stocks When Everyone is Selling?
You might require selling stocks if you:
Need the money
Your trading goals are met, and you want to exit the trade
Want to rebalance your portfolio
Your emotions compelled you to leave the trade
As there can be different reasons to sell the stock, different investing goals and investment plans can make people willing to buy the stock.
Institutions, corporate traders, individual traders, and market makers/specialists have different motivations and actions behind buying the stock. These include:
They are day-trading stocks
They have regularly scheduled investments to save for retirement, etc.
They are swing traders
They are buying the dip
They are covering short sales
They have limited buy orders
They are rebalancing their portfolio
They are exercising an option
They have the fear of missing out on a profitable trading opportunity
When Do You Have To Pay Back A Short?
There are no fixed rules regarding how long a short sale can last. The entity that lends the shorted shares can demand the investor to return the shares at any instant, with nominal notice. However, this rarely happens if the short seller regularly pays their margin interest and maintains the margin requirements.
Brokerage firms encourage traders to engage in short-sell as they greatly benefit through the interest commission they earn on the short-sale trades. Also, brokerage firms are prone to limited risk due to the restrictive margin rules on short-sale transactions.
However, a broker can exercise his right to forcibly close a short position if the shorted-stock rallies strongly, leading to massive losses and unfulfilled margin calls. The investor usually closes their position before the broker does it.
What Triggers a Short Squeeze?
Let’s look at a short squeeze scenario to understand what triggers it to happen:
You find an overvalued stock and take a short position.
Unlike your belief, the stock price increases and begins a short squeeze. This rise in stock price could happen due to: The company issuing a favourable earnings report, good news about the stock or its industry or increased buying in the stock.
As you realize you can’t purchase the shorted stock at a low price, you decide to purchase replacement shares at a higher price and return to your broker at a loss or buy more shares than required in hopes of covering your losses by selling them for profit.
Like you, most short sellers buy higher-priced shares to close their short positions and book losses. Such market activity further results in a rise in stock prices. It can create a feedback loop wherein short sellers' losses grow exponentially with time.
How Much Short Interest is Needed For a Squeeze?
Usually, securities with a high short interest of 20% or above have greater chances of building a short squeeze.
"Short interest" is the percentage of the total outstanding shares held by short-sellers. A high short interest percentage implies that more outstanding shares are being sold short.
What Is The Best Indicator For a Short Squeeze?
Some of the best signs that indicate a pending short squeeze include:
Substantial buying pressure causes heavy buying of many shares being sold short.
High short interest of 20% or above.
A high Short Interest ratio (SIR), or the number of days short-sellers need to cover their position, is above 10. The higher this number, the more chances of experiencing a short squeeze in the stock.
Relative Strength Index (RSI) less than 30. A stock with a low RSI implies that it is oversold and trading at a low price, possibly indicating a forthcoming price rise. Such a stock is ideal for experiencing a short squeeze.
What is an Example of a Short Squeeze?
A short squeeze involves a sudden increase in purchasing activity among short sellers due to the stock price rise.
It causes them to buy it back to exit their short trades and book their losses. This massive increase in buying activity further increases the stock’s price and compels more traders to cover their short positions.
Let us Understand it by a Short-Selling Example:
Suppose an XYZ Company has a short interest of 50%. Due to poor earnings, most traders have created a short position from $50, and the present stock’s price is $35.
However, the company reports remarkable earnings in the next quarter that causes it to double its price to $70. As most traders have shorted in the company’s stock, they would require to exit from their positions to curtail their losses.
When more buyers start buying the stock to cover their position, it will create purchasing pressure. It will, in turn, causes the stock value to increase to $80, making it more problematic for short-sellers.
What Happens If You Short a Stock and It Goes To Zero?
If you sell a stock at a higher price and the price of that stock goes to zero, then it is the best money-making opportunity for a short-seller. However, in this case, the stock (with a zero value) loses its entire value and is suspended.
To avoid this, short-sellers must do short-covering (buy back the stock) before the stock reaches zero. You would make a substantial profit by buying back a stock quickly before it becomes $0 and eventually be delisted.
What is The Difference Between a Short Squeeze and a Long Squeeze?
Before we understand the difference, let us determine what a squeeze is. It happens in markets wherein speculators trade in heavy volume, and several traders forcibly close their position due to the stock price moving against them.
A short squeeze occurs when many investors bet against a stock (or other tradable security), and its price suddenly shoots up, causing them to cover their positions by buying back the shorted stock. This unusual condition triggers a further rise in the stock price as short sellers exit their position to cut their losses.
On the contrary, a long squeeze occurs when the asset’s price reduces, and investors with long positions rush to sell out of their positions. This results in a further decline in asset price.
Other Differences Include:
During a long squeeze, the potential losses of a trader are limited to what they paid for the asset. However, investors holding short positions can face limitless losses in a short squeeze.
Additionally, a long squeeze has no fundamental basis for selling. It may be very brief or last for some time. It is when value-buyers or short-term traders who wait for oversold conditions buy the stock when its price falls "too low" and bid it back up.
A stock with limited shares available to the public is more prone to a long squeeze. It takes fewer people to create a significant impact on the stock price.
What Are The Most Shorted Stocks On The ASX?
Here is the list of the most shorted stocks on ASX:
Flight Centre Travel Group Ltd (FLT)
Betmakers Technology Group Ltd (BET)
Lake Resources N.L.(LKE)
Regis Resources Limited (RRL)
Block Inc (SQ2)
Megaport Ltd (MP1)
Inghams Group Ltd (ING)
EML Payments (EML)
ZIP Co Ltd (ZIP)
Nanosonics Ltd (NAN)
Breville Group Ltd (BRG)
De Grey Mining Ltd (DEG)
Polynovo Ltd (PNV)
Magellan Financial Group Ltd (MFG)
92 Energy Ltd (92E)
Kogan.com Ltd (KGN)
Idp Education Ltd (IEL)
Short selling can be a lucrative trading strategy to profit when a stock drops in value.
However, only expert investors should consider short selling due to the risks of losing "infinite" capital and being caught in a short squeeze. Thus, only try it after carefully assessing the risks involved.
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