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Short Selling for Rapid
Profits |
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What are the benefits of Short Selling? |
Many of the
world’s stock markets have enjoyed incredible gains since
1982 and investors have been pocketing steady, consistent
returns for over 2 decades now. During that time there
have been a few rocky patches that may have unsettled the
newbies but seasoned investors who held on have been doing
very well.
So why would you want to short
sell?
Given that stock markets around the world have
generally been heading up and during some periods (2003 - 2008
or the tech boom) the stock market has experienced incredible
bull market runs, one has to ask exactly why you would want to
short sell.
Before we uncover the benefits of short
selling we’ll discuss exactly what it
is.
Short selling enables traders or investors to
benefit from a fall in a stocks share price. Ideally your goal
is to make a profit as the stock you are trading falls in
value. Traditionally short selling has been reserved for the
very experienced traders, but since the advent CFDs, short
selling is now simple to understand and very easy to
execute.
Short
Selling example - Don't laugh too
much!
Imagine it’s raining outside and you need to
get some lunch but you don’t have an umbrella. So you ask your
workmate if you could borrow her umbrella and Krystal happily
agrees. Once downstairs you are approached by a suave looking
guy in an Armani suit holding a bunch of papers (probably a
lawyer!) and he doesn’t have an umbrella. He asks if he can buy
your umbrella.
Without a moments hesitation you say “Yes, you
can have it for $30” and he happily
agrees.
Problem:
You have just sold
something you don’t own and there is a chance Krystal
(the original owner) is going to get
upset.
Solution:
You run through
the rain to the shops, head to the nearest umbrella shop
(is there such a thing?) and you notice they are selling
an identical umbrella to the one Krystal lent you. Even
better news, it’s only $20.
So you hand over your $20 and discover that
you have just made a $10 profit and Krystal would be none the
wiser.
Who said there is no such thing as a free
lunch?
Quick run down of your profitable
short selling transaction
-
You sold something you didn’t own
(Krystal’s umbrella) for $30
-
You bought an identical umbrella back
for $20
-
You profit the difference which is $10
and netted a free lunch
Essentially that is shorting selling in a
nutshell. Sorry for the corny example but I’m sure you get the
point. Fortunately, when you short sell with CFDs you don’t
have to find someone on the other side of the transaction
(Krystal) willing to lend you the stock as your CFD broker will arrange that for
you with no fuss. Most CFD
providers on the Australian market will allow you to short
sell the top 200+ stocks so there is plenty of opportunity to
choose from.
Let’s have a look at a trading example with
some real numbers. We’ll look to short sell Toll Holdings and
profit as it falls in value.
Metastock® chart
courtesy of Equis
International
Short Selling CFD Example
Trade
Short Sell 1,000 TOL shares at $8.50 - Looking
to profit from a falling share
price
|
Action
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How to
calculate
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Result
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Total
Exposure
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1,000 CFDs @
$8.50
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$8,500
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Initial
Margin
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$8,500 *
10%
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$850
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Brokerage
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Total exposure * 0.1% or
$10
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$10
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Total
Outlay
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Initial margin +
brokerage
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$860
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TOL falls over a 18 day period to $7.44 and you
lock in profits the day after TOL hits your stop
loss.
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Action
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How to
calculate
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Result
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Sell
price
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$7.44 *
1,000
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$7,440
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~Brokerage
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$7,440 * 0.1% or
$10
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$10.00
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^
CFD
Finance
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Total Exposure * ((RBA -
2%)/365)
7,440*(7.25%-2%)/365)
18
days
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Approx $1.07 per
day
Approx $19.26 for
18 days
(credit)
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Calculating
your CFD
Profit/Loss
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Action
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How to
calculate
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Result
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CFD
Profit
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(number of shares*(exit-entry))
- trading costs
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(1,000 * ($8.50 - $7.44
(profit)) - $20 (brokerage) +
$19.26
(CFD
Finance)
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CFD Nett
Profit/Loss
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Profit
$1,059.26
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Return on
Investment
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(Nett Profit or Loss /
Margin) * 100
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124.61%
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So you can see from the profitable example above
that short selling is nothing more than selling the
stock or CFD first in order to buy it back at a cheaper
price. Remember, working out your profit with contracts for
difference (CFDs) is simply the difference between where
you get in and where you get out, regardless of whether
you trade long or short.
Remember, if that position had gone the other
way by the same amount it would have resulted in a loss of
$1,059.26 or $124.61% of your initial outlay.
To
view an example of a short sell that resulted in a loss click
here.
Conditions for short selling CFDs have
never been easier
Prior to the
rapid growth of contacts for difference (CFDs), people
who wanted to short sell had to find a full service
broker who would charge like a wounded bull or bear, pun
intended and the following stipulations would be put in
place.
-
You can
only short sell on an uptick (price must head up
before you can short sell it)
-
You have to put up 25% margin as a
minimum
-
You are restricted to trading only those
stocks the broker can find
in their portfolio to short
against.
-
The ASX
has short selling restrictions which means
brokers in Australia cannot short sell more than
10% of a company’s shares on issue. To view
the ASX short sell list (updated daily) CLICK
HERE.
With the
introduction of CFDs, traders now have access to the top
200+ stocks on the Australian markets and short
selling is as easy as clicking the sell button
first. There is no uptick rule and margins for some
CFD brokers are as low as
3% up front. That means you can short sell $10,000 worth
of a stock with only $300 of your
money.
Short selling
restrictions imposed by the ASX
Your CFD broker
is not immune to the short selling restrictions imposed
by the ASX but it is very rare for any company on the
Australian market to get close to total short sales of
10% of shares on issue. In the USA there are no short
sell restrictions and traders, fund managers and anyone
with an interest in the markets can short sell as many of
the company’s stock as they like. This can lead to a
short squeeze.
Early 2008 say
the collapse of many well established Australian
companies like ABC Learning centres, Allco finance and
Babcock & Brown. Hedge funds were to blame for their
aggressive short selling which drove the price of these
previously well capitalized companies
down.
Fueling the
fire was the fact that the company loans were tied to the
capitalization of the company and as the share prices
started to drop, company directors had to sell stock in
order to free up their margin calls. A beautiful cascade
in the share price developed and now you have businessmen
like Eddie Groves working for the company he built as an
employee minus the Brisbane Bullets and shiny red
Ferrari.
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