Short Trading: What is Short Selling?

 

Long and short refers to the direction of trade, as opposed to the timeframe of long term or short term.

Short Selling Definition

So what is short selling? How do you sell a stock that you don't own?

How do you explain this to someone who is unfamiliar with trading?

Simply put, the stock or CFD broker lets you borrow you the stock from an original owner, and then you sell the stock, and the value of the stock is put into your account. However, at a later date you are obligated to buy the stock back (known as 'cover') and give back the stock to the original owner. After this happens, the original owner is no different in that they still own their stock. The stock broker makes a commission on the sales. And you as the short seller have either made a profit or loss depending on your sell and buy (cover) price.

It's like there are 3 parties involved, but in this more complicated way. The definition of short selling can be simple when thought of in this way.

Short Trading Ban 2008-2009

In the middle of the global financial crisis of 2007-2010 there was a temporary ban on short selling in the US, UK and Australia among other countries in an attempt to control spiralling downward prices in stocks.

The ban also affected the list of shortable CFD stocks and shares even though they were derivatives of underlying sotck market products. This makes sense as if stocks or CFDs are falling fast, more and more people shorting the stock or CFD (that is, selling the stock) will cause more selling pressure which lowers the price of the stock even more.

In an effort to control this, short selling was temporary disallowed.

Special Notes About Short Trading

Here are some points about short trading CFDs or short trading shares that you should be aware of.

First is that you should check the commission or brokerage fees for short selling shares. They may differ from that of long trades or may be the same. Fees do vary greatly between providers or brokers.

Secondly, the margin requirement for shorting may be different to that of going long. Again this depends on your broker or provider but take this into account when trading or backtesting.

Thirdly, the list of shortable shares can and do change from time to time. The ban on short delling recently is unusual and not common, but even outside this situation, the list of shares or CFDs that you can short varies with each broker. So check out these lists when when backtesting and not just assume that the top 100, 200 or other list of stocks in an exchange can be all shorted.

Note:

All trading involves a high risk of financial loss, and the information on this site is for general information purposes only and is not financial advice in any form. Seek your own financial advice before taking any action.

All forms of trading involves risk of financial loss.

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