What is short-selling?
Short-selling is the act of selling an asset that you do not currently own, in the hope that it will decrease in value and you can close the trade for a profit. It is also known as shorting. Short-sellers tend to use this strategy as a method of speculation or as a way of hedging downside risk.
Short-selling strategies can be carried out via a broker, but it is a complicated method, which means that it can be difficult to find a broker willing to lend you the shares to sell. This is why derivative products such as CFDs are becoming an increasingly popular method of short-selling.
In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional “long” position, where the investor will profit if the value of the asset rises. There are a number of ways of achieving a short position.
Pros and cons of short-selling
Pros of short-selling
Short-selling means that you have the opportunity to profit from markets that are declining in value, not just ones that are increasing.
Short-selling can be carried out in a variety of ways. The example above demonstrates the traditional method of short-selling via a broker, but traders will define short-selling slightly differently to investors. Thanks to the rise of online trading and derivative products – such as CFDs – traders can take a short position on thousands of markets without having to borrow the underlying asset.
They can be used in a speculative manner, taking naked short positions, or for hedging purposes (such as part of a spread trade).
Cons of short-selling
Short-selling can be a risky strategy, as assets can theoretically increase in value indefinitely. Leveraged products can increase risk further, amplifying losses when a market is heading upwards in price.
A good risk management is key when short-selling, using tools like guaranteed stops to prevent excessive losses. Using a guaranteed stop on the IG platform will incur a fee if the stop is triggered.
There’s also a recall risk, in the event that the stock lender wants to liquidate their position and therefore recalls the stock lent out, which in turn forces the borrower to liquidate their position at a potentially unfavourable time.