Jargon Busting with Hawksmoor: Selling Short
Equity investment used to be such a simple idea. You bought shares, the price went up and you sold them for a profit. If the price went down you held on, received the dividends and told everyone that you were a long-term investor.
There is however a Through the Looking Glass version of this world where traders sell first and buy after the price has fallen. Welcome to the upside-down world of the short seller.
Let’s tackle the glaring impossibility: how does one sell shares one does not have? A short seller must first borrow shares from a stock lender. The lender – perhaps a pension fund holding gargantuan amounts of every share – will charge a lending fee and expect to be paid any dividends.
Short selling can quickly become loss making: the seller is exposed to rising prices plus the fee and is liable for dividends. A buyer’s maximum loss is the amount invested: a short seller’s maximum loss is unlimited.
‘Going short’ can at times get down and dirty. Sellers can accuse companies of anything from misfeasance to outright fraud. Companies return with accusations of libel, slander and market manipulation. The hugely acrimonious spat between Quindell and Gotham City was a textbook example.
Yet short selling need not involve attacking a business. If we believe Shell is cheap relative to BP, we could short BP and buy Shell. All we need thereafter is that Shell rises more, or falls less, than BP.
These trades can be a magic potion that profits irrespective of the general market direction!
Written By Ian Woolley CFA – Senior Investment Analyst
Hawkmoor Investment Management http://www.hawksmoorim.co.uk/
Photo by Amtec Staffing www.amtec.us.com