Short Selling
We wrote this article to educate our readers on short selling. Have you ever sold a stock short? If not, why not? Did your investment advisor decide on your behalf you are either unqualified or not sophisticated enough to understand short selling? Read this article and decide for yourself if short selling is a tool you. Shorting is just another tool - no more; no less - and those who impose steadfast rules against shorting may suffer in performance by taking a "long only" approach. Short selling stocks and other financial instruments is an important tool we intend to introduce to VHF subscribers.
What is short selling?
Short selling is selling a particular item you do not own because you believe it will decline in value. In the investment world professionals short sell stocks, bonds, options, and futures. Although VHF will short any financial product from time to time, we’ll focus on the U S equity market to illustrate short selling to our viewing audience. The definition of short selling a stock, is to sell a stock you do not presently own.
Why do the pros sell stocks Short?
There are a variety of reasons to short financial instruments: the belief it will decline in value cited above, to hedge a trading position, arbitrage trades, pairs trading, and momentum trades, etc. The point here is that if the big boys find it important to short why don’t you?
How to short stocks
First, you must have a margin account with a broker dealer and therefore, you must fulfill the due diligence requirements of the executing broker broker/dealer. Once the margin account is opened, determine the VHF strategy to be implemented and away you go. Let’s open with a simple institutional example, shorting 10,000 Cisco Systems (CSCO) at 37 in hopes CSCO trades lower. The goal of short selling is the same as from the long side buy low and sell high but the process is reversed: we sell high in the hopes of buying back at a lower price later. Following the example above, this is how to execute our strategy. Look at the CSCO market say 37 to 37.125 (1/8 = .125) with the last trade at 37. First call is to stock loan department where I must secure a “borrow” on the number of shares I wish to short and wait for what is called “ locator number”, this confirms that I have located a borrow for delivery to the buyer. Next place the order with a market maker, or ECN, since CSCO is a NASDAQ stock. Sell short 10,000 CSCO at 37, the ticket at this point must be marked as a short sell and time stamped. If the next trade in CSCO is 37 or greater I should receive a fill or partial fill on my CSCO order. Note the print of 37 or 37 plus is important for I need a plus tick or zero plus tick to execute the short. Let’s now assume the stock trades at the appropriate level to execute our entire order. I’m short 10,000 shares of CSCO at 37 assuming the zero plus tick was 37.
Retail (individuals) short selling seems simpler but still has to follow the some rules. The retail investor simply obtains a market either from an online quote machine or broker and enters the order either online or verbally to a broker. In this case sell short 1000 CSCO at 37, just like before. In the retail example the broker is responsible for borrowing the stock for delivery, time stamping, marking the ticket as a short sell, and observing the up tick rule for execution. The retail investor has to sit and wait for his online trading system or broker confirms the fill.
Uptick Rule Most stocks require that a stock can only be sold short on an uptick. However futures, options and some hybrids, such as the NASDAQ 100 QQQs can be short sold at any time. Most individuals are one dimensional, meaning they buy and hold and forget about selling until they either need the money or market conditions dictate their sleeping habits. This has worked well for those with good professional money managers but recent markets illustrates good professionals are hard to find and are worth their weight in gold. But many money managers do not perform in the real world; money mangers move, retire and charge handsome fees. VHF is here to give you ideas and strategies for optimal results. This article explains the concepts and mechanics of shorting, to be used when the market or strategy dictate a short sale. VHF will not sell the sophisticated small investor short when it comes to presenting opportunity to our clients. After all who cares more about your money than you? Approved Investors who never consider short selling must be willing to ride out the bad times or be adept at converting their holdings to cash before downturns. These two strategies are not easily accomplished in reality particularly if there is an extended downturn as in the 1970’s.
Some dangers of selling short
What is short selling?
Short selling is selling a particular item you do not own because you believe it will decline in value. In the investment world professionals short sell stocks, bonds, options, and futures. Although VHF will short any financial product from time to time, we’ll focus on the U S equity market to illustrate short selling to our viewing audience. The definition of short selling a stock, is to sell a stock you do not presently own.
Why do the pros sell stocks Short?
There are a variety of reasons to short financial instruments: the belief it will decline in value cited above, to hedge a trading position, arbitrage trades, pairs trading, and momentum trades, etc. The point here is that if the big boys find it important to short why don’t you?
How to short stocks
First, you must have a margin account with a broker dealer and therefore, you must fulfill the due diligence requirements of the executing broker broker/dealer. Once the margin account is opened, determine the VHF strategy to be implemented and away you go. Let’s open with a simple institutional example, shorting 10,000 Cisco Systems (CSCO) at 37 in hopes CSCO trades lower. The goal of short selling is the same as from the long side buy low and sell high but the process is reversed: we sell high in the hopes of buying back at a lower price later. Following the example above, this is how to execute our strategy. Look at the CSCO market say 37 to 37.125 (1/8 = .125) with the last trade at 37. First call is to stock loan department where I must secure a “borrow” on the number of shares I wish to short and wait for what is called “ locator number”, this confirms that I have located a borrow for delivery to the buyer. Next place the order with a market maker, or ECN, since CSCO is a NASDAQ stock. Sell short 10,000 CSCO at 37, the ticket at this point must be marked as a short sell and time stamped. If the next trade in CSCO is 37 or greater I should receive a fill or partial fill on my CSCO order. Note the print of 37 or 37 plus is important for I need a plus tick or zero plus tick to execute the short. Let’s now assume the stock trades at the appropriate level to execute our entire order. I’m short 10,000 shares of CSCO at 37 assuming the zero plus tick was 37.
Retail (individuals) short selling seems simpler but still has to follow the some rules. The retail investor simply obtains a market either from an online quote machine or broker and enters the order either online or verbally to a broker. In this case sell short 1000 CSCO at 37, just like before. In the retail example the broker is responsible for borrowing the stock for delivery, time stamping, marking the ticket as a short sell, and observing the up tick rule for execution. The retail investor has to sit and wait for his online trading system or broker confirms the fill.
Uptick Rule Most stocks require that a stock can only be sold short on an uptick. However futures, options and some hybrids, such as the NASDAQ 100 QQQs can be short sold at any time. Most individuals are one dimensional, meaning they buy and hold and forget about selling until they either need the money or market conditions dictate their sleeping habits. This has worked well for those with good professional money managers but recent markets illustrates good professionals are hard to find and are worth their weight in gold. But many money managers do not perform in the real world; money mangers move, retire and charge handsome fees. VHF is here to give you ideas and strategies for optimal results. This article explains the concepts and mechanics of shorting, to be used when the market or strategy dictate a short sale. VHF will not sell the sophisticated small investor short when it comes to presenting opportunity to our clients. After all who cares more about your money than you? Approved Investors who never consider short selling must be willing to ride out the bad times or be adept at converting their holdings to cash before downturns. These two strategies are not easily accomplished in reality particularly if there is an extended downturn as in the 1970’s.
Some dangers of selling short
- Caught in a short squeeze and forced return of the borrowed stock.
- Short sellers are responsible for all dividends due the rightful owner.
- Change in rebate rate for the institutional trader could be costly.
- Failure to implement risk management procedures will lead to losses since a short has a limited profit potential (from price we short at to zero) and unlimited loss potential (from price we short at to as high as stock goes).
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