The Stock Market: What is Shorting A Stock?

When we talk about stocks, it often involves buying a stock first. Do you know that you can actually sell a stock first before buying it?

You might have heard of someone saying “go long” or “go short”, but what does it mean in trading terms? In a very simple way, going long simply means to buy, and going short means to sell!

When an investor goes long on an investment, it means that he has bought a stock in the hope that its price will rise in the future.

On the other hand, when an investor goes short, he is anticipating a drop in share price in order to profit from it.

This concept is common in futures and CFD trading, but less so in stocks. Why? This is because there are usually restrictions with regards to shorting a stock, increasing the risk of possible loss for the investor.

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Why Do People Short-Sell?

As you can see, the stock market does not rise forever. So what do you do if you think the prices are falling but still want to invest?

Short-selling allows an investor to profit from a bearish market so that you do not need to sit out and miss an opportunity for profit-making when the market is on a decline.

Without short-selling, it can be very difficult to make money when the market is in a down-cycle.

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Sometimes, economic events or an expected decline in share price of a company can be an opportunity for short-sellers as well.

Other than profiting from a downcast market, shorting can also be a strategy for protecting other investments or your portfolio, otherwise known as hedging.

2 Types Of Short-Selling

Short selling can either be “covered” or “uncovered” (also known as “naked” short selling). In ‘covered’ short selling, the seller has actually borrowed the securities to fulfil his obligation to deliver the securities.

In a “naked short”, you do not have any stocks on hand before you sell. Instead, you will need to buy back the stock that you technically have sold at some time in the future.

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For a covered short, retail investors can make use of such facilities offered by brokers called “securities borrowing” in order to cover their short-selling activities.

For a naked short, investors in Singapore will be required to buy back the short-sell before the close of day in order to avoid a “buying-in” by SGX.

Penalties On Naked Short

If you do not have the required shares in your account on the due date (T+2), SGX will conduct a buy-in of the shares on the market to satisfy the delivery obligation.

Usually, your broker will contact you at the end of day 1 to let you know this and advise that you do a securities borrowing in order to avoid the hefty penalties and processing fees involved on the SGX side.

Other things to think about before you short a stock – the stock you are buying might not be volatile enough for you to make a profit even if you covered the short at the end of the day.

You’ll still need to cover the trading fees so unless you are sure that the share price of a stock will drop substantially during the day, there is little incentive to do a naked short on a stock on the SGX.

The Safer Way To Short – CFD

CFD stands for Contracts For Difference. CFD is an agreement between two parties to exchange the difference between the opening price and closing price of a contract.

The advantage of trading CFD is that you can choose to short stocks using CFD without the fear of penalties. It allows you to buy when you think the price might go up, and sell first when you think the stock price will fall.

CFDs give you the flexibility of allowing you to profit regardless of price direction.

The main difference is that CFD is a derivative and a leveraged product, which could pose more risk as compared to trading shares.

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Lynette Tan

Lynette has more than six years of experience in financial analysis and writing, having stepped foot in the financial world as a commodities analyst. With a passion for personal investing and financial literacy, she hopes to help others gain investment knowledge by making investment concepts plain and simple for the man on the street.

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