Shorting in trading: what it is – Bison Capital Wealth

In this lesson, you will learn :

What is a short position
Risks of trading short

The practice of taking short positions has come under the spotlight of widespread scrutiny amid the coronavirus pandemic. Critics argue that short positions lead to market manipulation and are often used to target firms for destruction.

WHAT IS A SHORT POSITION

A short position is a method that many traders use to make a quick buck, as this way they can increase the size of their capital in the hope of making additional profits.

Let’s take a simple example. Let’s say William is eyeing shares of Shard Industries, which is currently trading at $75. He firmly believes that the stock’s value will inevitably fall, so he decides to open a short position in the stock. He borrows 150 matching shares totaling $11,250 from a broker and opens a short position by offering these shares to another buyer. Now all William has to do is wait.

Two weeks later, Shard Industries publishes its quarterly earnings report – its worst ever. This, combined with other factors, causes the stock to drop 40% to $45.

William decides to buy back the shares to then return them to his broker. Considering they cost him $6,750, he is left with a profit of $4,500. However, commissions and fees will likely eat up that amount a bit.

REGULATORY

Although shorting in trading was invented far from yesterday, the technique is increasingly being criticized, especially amid the current panic in the markets. In response to the coronavirus pandemic, regulators around the world have taken steps to limit traders’ profits when markets are falling.

In the most affected European countries, such as Italy, Spain and France, restrictions on short positions were hastily imposed on companies that were considered the most vulnerable. And in late March, it was decided to extend the ban for another three months for all listed stocks.

However, not all states followed suit and began to ban short positions for trading. For example, Great Britain, which during the 2008 crisis actively introduced such bans, decided not to resort to them this time. As a result, hedge funds and ordinary traders were free to use short positions on the stock exchange.

This approach to short positions caused disagreement between the Financial Conduct Authority (FCA) and the Bank of England. According to the former organization, markets should remain open and short positions could help them work in a uniform manner. As Andrew Bailey, the Bank of England’s new governor, has said in turn, those who engage in short positions are unlikely to be acting in the best interests of the British economy.

RISKS OF SHORT TRADING

Of course, trading short in trading does not guarantee profits. The stock market can fall as well as rise and there is always the chance of losing a considerable amount of money.

Let’s go back to the example of William, who borrowed 150 shares of Shard Industries at a price of $75 and then decided to open a short position. Another possible scenario is that even though the price dropped to $45, he got greedy and decided to wait for a bigger drop. And then Shard announced that it would be bought out by another large firm. This unexpectedly caused the company’s stock to skyrocket to $100 per share.

Now William has to buy back the shares and return them to the broker. He ends up buying them at $95 a share and spending $14,250, or $3,000 more than the original cost. William is now probably very sorry that he decided to take a short position.

So, we have clarified what short positions are. A short position is a tool that can be used both as a way of aggressive speculation and as a means of portfolio diversification. It is obvious that in the coming months there will be further turbulence in the markets, which means that the debate about the possibilities of shorting in trading will not subside.

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