What does it all mean?
“Going short” is when you sell the shares of a company or an asset which you do not own. You make a profit if the shares fall and you then buy them back at a lower price.
It is regularly the preserve of “hedge funds”, but how do they do it?
“Short sellers” don’t own the shares being sold; they borrow them from specialist firms, usually custodian banks like, but not necessarily including, Pershing, and sell them at the current market price. They then buy the shares back to complete the trade and return the borrowed shares to the lender. If the shares are bought back at a lower price, the trade is successful. If the share price has risen, the trade is unsuccessful, and the position is “covered” or closed. Trading may also be done in the derivatives markets.
Since the 2008 financial crisis the Financial Conduct Authority has published a daily list of short positions in company shares: this list shows which company is being shorted, what proportion of its shares is being sold short and who is shorting it.
The costs of borrowing the assets may mean that the time frame for this strategy is relatively brief. Costs depend upon several variables including: the income generated by the asset; the cost of money; the size of the company; the liquidity of the asset in the market; the level of distress of the company; and the volatility of its share price. This may encourage aggressive behaviour on the part of the “short seller”.
Risks of “selling short”
Buy-and-hold managers often say that the most they can lose on an investment is 100% while the amount they can make is unlimited; in “short-selling” the opposite is true: the most you can make out of a short is 100% but there is no limit to what you can lose. Hence the industry saying, “long and wrong but short and caught”.
When companies, markets or economies are looking vulnerable other buyers might emerge, intending to take advantage of depressed prices. Corporate mergers and private equity buyers present a risk to “short sellers” by paying a price above the current market price when a company is in distress.
Companies in difficulty can also turn themselves around and see their share price bounce back sharply after a restructuring.
A strong recovery in a share price can lead to a “short-squeeze”, also known as a “bear squeeze”, which forces “short sellers” to close their positions. As with all investments, the value can go down as well as up – even if as with “short selling” it happens in reverse.