Read this article to learn all about Share CFD Trading.
One way of making a profit from a falling share price is to go short on that share.
To go short the investor borrows the shares from a shareholder, sells them immediately and then buys them back at a lower price in the future.
Sounds complicated? It’s not really
Shares in ‘Widget Ltd’ might be valued at $10, if an investor thought that they might decrease from this value then they could go short by borrowing, for a fee, 100 shares from the stockholder and then sell them for $1000.
If the share price of company ‘A’ then falls as expected to say $2.50 then the investor could buy 100 shares back for $250 and then return them to the original shareholder and keep the $250 as profit.
The investor would make a loss though if the shares actually gained in value. Many see going short as unnatural, and this is why in times of economic recession the practice can cause controversy.
Indeed, during and after the collapse of Lehman Brothers in 2008 many, including the former CEO of Lehman Brothers Richard Fuld, tried to blame the short sellers for cashing in and causing instability and panic within the markets. In certain corners of the media they were portrayed as selfish opportunists and even unpatriotic; instead of completely rational traders reacting to a company that was in trouble because of its own management failings.
While many commentators still hold the view that short selling was at least partly to blame for the collapse of Lehman Brothers we are seeing an increasing amount of studies (and commercial books) concluding to the contrary. The argument will no doubt carry on for some time. Whatever your opinion is, short selling has certainly touched a nerve among regulators. In the US the Securities and Exchange Commission (SEC) recently added a new rule to restrict short selling when a stock is experiencing significant downard pressure, the trigger being if the price of a stock drops more than 10% in one day.
‘The rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market,’ commented Mary L. Schapiro, the chairman of the SEC.
In the EU the Committee of European Securities Regulators (CESR) has recently recommended the introduction of a pan-European disclosure regime which would mean investors reporting any significant net short positions to the relevant regulator and to the market.
How the market will react to these new developments will be very interesting. Short selling is seen as an advanced strategy, and while it has its advantages there are disadvantages. Because the short seller (borrower) effectively has a negative amount of shares they are liable to pay any dividends the company might pay on its shares to the lender.
Another thing to be wary of is that with short selling you are taking a position against the natural trend of the markets, in which prices tend to rise.
There is one way an investor can go short on a stock without actually having to borrow the physical shares and that is CFD trading. Shares trading allows you go short on share without having to borrow the shares from anyone.
When you trade share CFDs it’s up to you to decide whether you think a company’s share price will rise or fall.
There is no physical exchange of shares as you are only taking a position on the value of the shares in the future.
Because CFDs are traded on margin you can benefit from increased leverage. And that’s perhaps why investors are increasingly seeing CFD share trading as a more cost efficient and flexible way of dealing company shares.
The UK’s largest CFD provider is IG Markets.
They offer an extensive range of research resources and expert market analysis and commentary to help you increase your financial trading knowledge.
It’s always important to remember that CFDs are a leveraged product and while profits can be magnified so too can losses.
