An Introduction to Short Selling
Most of you will be familiar with the terms long and short by this point, but for those of you that don’t, here’s a little overview of what the two mean.
In the simplest terms, this is when you see the value of a stock going up! For example, investors in CrowdCube opportunities… When you enter into a long position you become the owner of the stock, and there’s nothing left to do at that point than ride the wave until you swagger down into the Lambo (okay, KIA) garage.
Okay then, onto short positions, this is where it gets a little bit funkier. These are the positions you take when you see the value of a stock going down, how do you do this you might ask? Well it typically involves borrowing the overvalued stock from one of your generous buddies (or hungry hungry brokers), and then selling it, before watching it tank.
You’re right, it was too easy, let’s have a look why.
Old matey boy that lent you the stock will expect it back at some point, so you need to hope and pray that the stock does fall as you expected, so you can buy it back in the market for less than you sold it for, before returning it to it’s rightful owner. Now, they won’t be too happy you’ve made a few bob to their loss, so you’ll likely be paying them some interest for the privilege.
Oh, did I forget to mention the dividends? Well as you never actually owned the stock, if the company in question pays any dividends whilst you’ve been short, they remain the rightful property of the poor schmuck you’ve just taken advantage of, so don’t forget to factor that in.
So, even if your call is right, going short can still be a costly exercise… But what if the stock keeps going up, instead of down? This is where you strap in and grab the sick bucket. It’s important to remember with shorting, your gains are a maximum of 100% (if the company goes bust), however, your losses are potentially unlimited.
Let’s take a look at a high profile example:
Back in 2013, a well known activist investor by the name of Bill Ackman took out a $1bn short position against Herbalife. Convinced it was a pyramid scheme, he held a 3 hour conference outlining his strategy, when he began his short, the share price was at $45, and by the time he finally exited earlier this year, Herbalife had rallied more than 100%, reaching $113 at it’s peak before the stock was split. Bill’s firm Pershing Square never disclosed the amount of the loss, but the above can show you how risky going short can be, if you have Netflix, you can find out more about the story by watching Betting on Zero.
There is so much more to shorting than what I’ve covered above (margin, momentum and short squeezes just to name a few), so be sure to check out my deeper dive in the second part to this article .
Stay safe out there, and remember, your capital is at risk, whether long or short!
