Short selling

Hughesy84

Ok iv got my head around normal share buying, tax isssues etc....now my next question.

Whats the crack with short selling??

Quick question or two - which hopefully there is a quick answers to.

If I want to short sell some shares at say 5000 @ £30, with the hope they drop to £29 = £5k profit......then what fees are involved and is there anything I should know before doing it?

Think the other day one company that contacted me said I could do it with them, and only need to pay 10% of the actual value of the shares upfront!?!? Is this normal or is this so I have to pay them a bigger chunk of profits?

Thanks :T

pinkteapot

I'm 99% sure you're aware of this anyway but just in case, and for the benefit of anyone else reading, with short-selling there is unlimited risk. If you buy a share at £30, the most you can lose is £30. If you short a share at £30, your potential losses are unlimited as there is theoretically no limit to how far up the share price can go.

Hughesy84

Yeah i understand that the share price could go up, and if im hoping for a drop then its going to cost me money.

Just a question about that though - how do they ensure that you have the funds to cover it?? Or dont they? So I plan to short it @ £30, but it actually doubles to £60 (far fetched I know) - I therefore owe over £150k...how do they check you can cover it?

tradetime

Normally it has to be done in a margin account, commissions will be the same as for long trades, ie you are selling a share and then buying it back. Other than that, since it is a trade done on margin there will be a daily financing fee in keeping with margin which varies from broker to broker, often something like base rate + 1.5% which would then be divided by 365 x the number of days you hold the position

darkpool

instead of selling short buy a "put" option. it gives you the right to sell shares at a predetermined price in the future.

savemoney

StockServant Hit the :spam: button folks

Hughesy84

savemoney wrote: »

StockServant Hit the :spam: button folks

Whats this for??

Hughesy84

darkpool wrote: »

instead of selling short buy a "put" option. it gives you the right to sell shares at a predetermined price in the future.

Interesting - care to go into more detail please??

Hughesy84

tradetime wrote: »

Normally it has to be done in a margin account, commissions will be the same as for long trades, ie you are selling a share and then buying it back. Other than that, since it is a trade done on margin there will be a daily financing fee in keeping with margin which varies from broker to broker, often something like base rate + 1.5% which would then be divided by 365 x the number of days you hold the position

Ah ok - yes I have seen that info in Galvans info they sent me - think its £1.10 for a £10,000 hold per day.

They have also mentioned CFD's - take it they are even more high risk? :j

Stochasticity

Hughesy84 wrote: »

Yeah i understand that the share price could go up, and if im hoping for a drop then its going to cost me money.

Just a question about that though - how do they ensure that you have the funds to cover it?? Or dont they? So I plan to short it @ £30, but it actually doubles to £60 (far fetched I know) - I therefore owe over £150k...how do they check you can cover it?

How this usually works is that you're required to commit a certain amount of money to your bet to cover losses. This is known as the 'margin'. As the price moves, you have to maintain the margin (and this means if the price moves against you, you have to commit more and more of your money to the bet to cover the possibility of future losses). If you fail to maintain the margin then your position is automatically closed and a loss is locked in out of the money that you've already committed to the bet.

Suppose the margin is £20,000. You short 5,000 shares at £30. If after the first day, the shares fall to £29, the £20,000 margin will contain £15,000 of your own money and £5,000 profit. You withdraw the £5,000 of your own money that's released from the bet.

On the second day, however, the shares rise to £31. Your £20,000 margin is now down to £10,000 and you're currently nursing a loss of £5,000. You will need to top up your account with another £10,000 in order to maintain the margin. If you don't fund your account with another £10,000, then your position will be closed, your £10,000 will be returned to you for you to withdraw and you'll have £15,000 in total, a loss of £5,000.

Suppose you add the extra £10,000 in funds. On the third day, the price moves against you again to £33. Again, the margin is down to £10,000, so you need to commit another £10,000 to keep your position open or a loss of £15,000 will be realised.

So you could only lose £150,000 if you had £150,000 to lose.

tradetime

Hughesy84 wrote: »

Ah ok - yes I have seen that info in Galvans info they sent me - think its £1.10 for a £10,000 hold per day.

They have also mentioned CFD's - take it they are even more high risk? :j

The fee will vary from broker to broker, just as interest payed on normal loans varies from bank to bank. So that is a cost that would have to be deducted from your profit, or added to your loss, along with the standard commissions they charge.

As the post above points out, your account would require a sum of money or other securities (initial margin) to cover which allows you to open the position, this is your initial "capital cushion" should the position move against you. Again, how much initial margin is required will vary from broker to broker and they will normally calculate it based on the volatility of the market. Once the position has been established, maintenance or variation margin may need to be added if the position moves against you enough to threaten the minimum margin requirement.

Personally I would recommend someone proves to themselves that they are proficient as a trader before taking on short positions as it is very difficult for a short position to be morphed into anything other than a trade.
For example, many people fancy themselves as traders, they may perhaps have watched a stock for a few days and noticed that after a morning dip it has a rally in the afternoon. So they endeavour to conduct a daytrade, buying the dip. Unfortunately the stock does not perform that day as expected, not wishing to accept a loss they decide it should be a swing trade, and they hold it for a few days or weeks, at the end of this the stock is still below cost, so it becomes a position trade, and then an investment. Thus a daytrade has morphed into an investment. This can work because in general stocks and markets rise over time, it costs nothing to hold the stock, and if a dividend payer you even get paid to hold.
This propensity for stocks and markets to rise obviously works against you in a short, the longer you are forced to hold the more risk the stock will not fall, and you must pay to hold. Therefore it is important that you have learned the discipline to plan a trade, and stick to that plan, taking the loss if it doesn't go to plan.

As for CFD's, they're not really my thing, but I would say they are not inherently more risky than anything else provided you fully understand the increased leverage they may allow.

An option contract as also stated above may be another way. In the case of purchasing put options it gives you the right, but not the obligation to sell the underlying stock (or security) at a specific price, by some specific time in the future. The advantage of the option route is that your potential loss is known beforehand, and capped.
The main disadvantage compared to a straightforward short, is that with the short you basically (within reason) only need to be right about direction. Buying an option, you need to be right about direction, and to a considerable degree the magnitude of the move, and the timeframe during which it will happen.