Read this article to learn all about Share CFD Trading.
One way of making a profit from a falling share price is to go short on that share.
To go short the investor borrows the shares from a shareholder, sells them immediately and then buys them back at a lower price in the future.
Sounds complicated? It’s not really
Say a single share in company ‘A’ is currently valued at $5, an investor wanting to go short could borrow (for a fee) 100 shares from a shareholder in company ‘A’ and then sell them immediately for $500.
If the share price of company ‘A’ then falls as expected to say $2.50 then the investor could buy 100 shares back for $250 and then return them to the original shareholder and keep the $250 as profit.
The investor would make a loss though if the shares actually gained in value. Many see going short as unnatural, and this is why in times of economic recession the practice can cause controversy.
Indeed, during and after the collapse of Lehman Brothers in 2008 many, including the former CEO of Lehman Brothers Richard Fuld, tried to blame the short sellers for cashing in and causing instability and panic within the markets. The picture painted of short sellers by certain media sources was of greedy, immoral opportunists feasting on the sad demise of a once great financial institution, while in reality it was perhaps more realistic to blame the events on a succession of poor decisions made by management.
In fact there is an increasing amount of evidence building to suggest that the short sellers were not to blame at all. One thing is for sure, the global discourse will continue. Regulators have, nevertheless, reacted to these events. The Securities and Exchange Commission (SEC) has recently approved some restrictions on short selling which will apply if a company’s stock falls more than 10% in one day.
The SEC’s chairman Mary L. Schapiro: ‘The rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market’.
Meanwhile over in the EU the Committee of European Securities Regulators (CESR) has put forward a series of pan-European measures called disclosure regimes that would mean investors declaring any short positions to the market and the relevant regulator.
How the market will react to these new developments will be very interesting. Short selling is seen as an advanced strategy, and while it has its advantages there are disadvantages. If you have gone short on some shares and the company then pays a dividend you are liable to have to pay the lender the value of the dividend.
Also, as markets generally tend to trend upwards then you will always find yourself trading against the natural flow.
There is one way an investor can go short on a stock without actually having to borrow the physical shares and that is CFD trading. Shares trading allows you go short on share without having to borrow the shares from anyone.
When you trade share CFDs it’s up to you to decide whether you think a company’s share price will rise or fall.
You don’t actually own the shares, you’re just taking a position on the future direction of them.
You trade CFDs on margin, that is, instead of paying the full value of the underlying financial instrument you pay a small initial deposit which can allow you leverage of up to 20 times your initial outlay. And that’s perhaps why investors are increasingly seeing CFD share trading as a more cost efficient and flexible way of dealing company shares.
The UK’s largest CFD provider is IG Markets.
They offer an extensive range of research resources and expert market analysis and commentary to help you increase your financial trading knowledge.
It’s always important to remember that CFDs are a leveraged product and while profits can be magnified so too can losses.