Short selling is an investment strategy where an investor profits if the value of an asset falls, contrary to the conventional “long” position, where an investor profits if the asset’s value rises. There are multiple ways to achieve a short position, including physical short selling, futures, forwards, options, and swaps.
Physical Short Selling
Physical short selling involves borrowing assets, such as shares or bonds, and selling them. The investor later repurchases the same type of securities and returns them to the lender. If the price has fallen, the investor profits from the difference. However, if the price rises, the investor incurs a loss. The short seller usually pays a fee to borrow the securities and reimburses the lender for any cash returns, such as dividends, during the lease period.
How to Achieve a Short Position
Short positions can be achieved using futures, forwards, or options, where an investor assumes an obligation or a right to sell an asset at a future date at a fixed price. If the asset’s price falls below the agreed price, the investor can buy it at a lower price and immediately sell it at the higher price specified in the contract. Short positions can also be achieved through contracts for differences (CFDs), which are agreements between two parties to pay each other the difference if an asset’s price rises or falls.
Margin Requirements for Short Selling
Short selling can incur liabilities if the price rises. Typically, a short seller must post a margin to their broker as collateral to ensure that any liabilities can be met and post an additional margin if losses accrue. Similarly, short positions in derivatives often require posting a margin with the counterparty. Failure to post the margin promptly may result in the broker or counterparty closing the position.
Short Selling in the UK and US
It is legal and commonly practised in both the UK and the US, particularly in public securities, futures, or currency markets that are fungible and reasonably liquid. Traders and fund managers may use short positions to hedge risks in a long position or a portfolio, while speculators may sell short to profit from an overvalued instrument. Learn more about the tax implications of trading in the UK.
Websites for Short Selling
Several websites and online brokers allow investors to short sell. Some popular options include:
1. Interactive Brokers: A global online broker offering a wide range of trading products, including short selling.
2. TD Ameritrade: A US-based broker offering trading services, including short selling, to individual investors.
3. E*TRADE: Another US-based broker that provides trading platforms and tools for short selling.
4. IG: A UK-based broker specialising in CFDs, spread betting, and share dealing, allowing investors to take short positions.
Remember to carefully research and evaluate brokers before choosing one for short selling, taking into account factors such as fees, account minimums, available trading tools, and customer support.
This is a legitimate investment strategy that enables investors to profit from falling asset prices. It is practised in various financial markets, including the UK and the US. However, never underestimate that short selling carries risks, as potential losses are theoretically unlimited, therefore it is extremely risky and not recommended for novice investors. Always speak to a qualified professional before investing. The aim of this article was to aid understanding and not to encourage risk-taking. Always conduct thorough research, consult with a financial advisor, and understand the risks involved before engaging in short selling.
Don’t miss out on valuable insights and tips for successful investing. Check out our previous post about hedge funds and comparison to ETFs, which offers valuable advice for investors of all levels.