What is short selling
Short selling is a trading technique that allows the investor to take advantage of falling markets without waiting for the drop to enter the market. Short selling is defined as selling financial assets such as stocks, currencies or gold in without owning this asset and then repurchasing it when the price drops and taking advantage of the difference between the selling price and the purchase price.
Advantages of short selling
Short selling has two main advantages for the investor, as he gets an opportunity to speculate and take advantage of different market conditions, whether it is rising or falling. Short selling is also used to hedge buying positions and manage risks if the prices of the assets you own fall and you prefer to keep them.
Speculation using short selling:
Short selling is a popular way to give traders the opportunity to take advantage of different market conditions, whether bullish or bearish.
Many speculators tend to sell short because they believe that the decline is faster than the rise in the financial markets and because fear controls the trader, which makes the opportunity to benefit from the decline and achieve higher profits.
Hedging using short selling:
Investors who want to take advantage of the market's rebound phase while maintaining their positions can use the method of short selling which gives them an opportunity to take advantage of the short-term price rebound while maintaining a long-term uptrend.
At the same time, investors use short selling to cover price differences during the forecast period for important news that may have a significant impact on the market with the aim of mitigating the risk of a rapid price drop.
Disadvantages of short selling
For short sale the disadvantages are:
One of the main risks of short selling is that there is no limit to the risk that investors take when the price of the assets sold by them rises, especially if the purpose of short selling is speculation and not hedging. It can drop to a level below zero, so the risk of loss due to rising assets is considered unlimited compared to the risk of decline.
Therefore, investors who take advantage of short selling are at risk of incurring losses that may exceed the value of their total capital and could become indebted.
Because companies announce specific dates for who is entitled to receive dividends, stockholders are limited to a specific date, usually the date of a general meeting, and are eligible to receive dividends in this case.
In the case of a short sale on a date before the dividends maturity date, and selling the stock after the expiry of the maturity period, the short seller becomes debited for the value of the dividends, which may be greater than the value of the profits obtained from the decrease in the price. As a result of the decrease in the price, the short sale has achieved profits and But he lost it in exchange for paying the dividend compensation that the share was entitled to.
sudden retail risk
Some companies divide themselves for several reasons such as separating the non-producing units of the company from the profitable units of the company, which leads to the company's transformation into two or more companies.
In this way, the short seller becomes debited by several shares for each share he sold from the basic company, which exposes the movement of the two companies to move in a different direction, which leads to doubling the risks of the position, as the price of the company that includes the produced units rises due to its disposal of the unproductive unit and the price of the company decreases The new, separate unit that includes the unproductive unit, and therefore the loss resulting from the increase in the price of the first company is higher than the profit achieved from the decrease in the price of the second company.
Possibility of short selling
It is very difficult or even impossible to accept someone to lend their shares individually to another investor, and here, investors use two main methods of short selling, either through stock brokers or CFDs.
Short selling through a broker
In this case, the broker supplies the investor with the assets, and the transaction is credited to the investor’s account, the investors can only move positions through trading brokers by providing the trading broker with guarantees against loss in the form of margin.
If the value of this insurance decreases, the investor has reached the stage of margin claim or the stage of margin warning, and the investor must choose to close the short selling position or accept the loss by deducting it from the investor’s margin balance, but if he wants to continue the position, he must increase The amount of margin available in his trading account with the broker.
Short selling through CFDs
CFDs are contracts that are used in order to profit from price differences without actually owning the underlying asset.
The contract for difference is priced through the secondary market or over-the-counter trading, and therefore the price includes all expenses and costs related to the asset, and the price is adjusted based on any additions or discounts to the share such as dividends and others.