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Shorting stocks, part of the wider short selling strategy, is a way for traders to speculate on the possibility of declining value for stocks, as opposed to profiting from increases. This trading strategy works on the principle of selling a depreciating security through a broker before buying it back at a lower price and keeping the difference as profit.
The intricacies of selling short
Here’s a quick example of shorting stocks:
If a trader has 10 shares in a company and sells them on the stock market for £10 each, they will have £100. If the price then drops to £5 per share, they can use this £100 to buy back all 10 shares. The broker gets their shares back and the trader keeps the £50 profit. While there may be commissions, fees and interest to pay, the trade was successful.
While this may sound straightforward, shorting stocks is an advanced trading strategy that poses the potential for both significant gains and losses. One of the biggest factors to keep in mind is that while a share price can only drop so far, it can increase to millions of pounds, so the potential for losses far outweighs the overall level of profits that can be made.
Read more about shorting stocks here.
Recent examples of shorting stocks
The good news for traders who use this strategy is that the Financial Conduct Authority (FCA) has a list of the most shorted stocks – and this is updated daily. It can help traders to gain some worthwhile insight into market trends, movements of professional investors and even illustrate companies that may be heading for a downturn. With this list in mind, some recent examples of shorting stocks can be a good indicator of when to get involved and with which companies.
According to Morningstar, online fashion retailers Boohoo and ASOS are the most shorted companies in the UK in November. These have been holding the top spot for the past few months and this is potentially a reflection of the current decline in consumer trends and the cost of living crisis in the UK. Other companies experiencing difficulties in the retail environment are Naked Wines, Curry’s and Kingfisher. Even food delivery service Deliveroo has been a recurring name this year.
Companies in other sectors such as the airline industry and investment management are seeing a decline in shares, namely EasyJet, abrdn and Hargreaves Lansdown.
Advantages and disadvantages of short selling
Pros:
- The industry is well-regulated
- This strategy is widely used
- Short selling can promote liquidity and help to stabilise the market
- Companies can reduce risk in their portfolios
Cons:
- Potentially unlimited losses
- Fees are subject to sudden changes
- No access to dividends for traders
- Margin calls
Final considerations before shorting stocks
As with any trading strategy, there can be reasons to get involved alongside a host of potential pitfalls. Shorting stocks is no different and poses a fair share of both risks and rewards for traders, even when they have the right knowledge and experience. As the main goal of short selling is to speculate on the declining share prices of companies, some traders may feel the practice is unethical, but this isn’t a consideration that needs to be taken into account when opting to use it as your chosen method.
The FCA has recently implemented some new rules for this trading strategy in an effort to increase transparency in the niche, so it may be worthwhile to undertake some research before entering positions to ensure that you remain compliant.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when spread betting and/or trading CFDs. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.
Marketing for CFDs and spread betting is not intended for US citizens as prohibited under US regulation.
