The trading of stocks and shares can be as straightforward or as complex as the trader desires. In some cases, you don’t even need to own the underlying asset to be able to interact with the market and potentially make an exciting profit. Short selling is a technique that falls into this category. In this article, we will introduce the approach and explain how it works so you can decide whether to try it for yourself. We’ll also define stock CFDs and their purpose.
How Does this Apply to the Market?
Short selling, where borrowed stock is sold, is where the seller only deals in what they have purchased themselves. The term refers to the borrowing of stocks or shares from their owners and then selling them. The aim of the short seller is to wait until those have reduced in value, then buy them back and return them to their owner, profiting from the difference.
What Are Stock CFDs?
One significant aspect of this tactic are stock CFDs, or contract for difference”. These contracts are agreements surrounding the exchange of the difference between values, rather than the exchange themselves. By entering into a CFD, a trader can profit from stocks and shares at any time – whether their current value is high or low – and will not usually have to pay stamp duty on those profits.
Why Do Shareholders Lend this Way?
Short sellers will commit to a transaction that they believe are likely to drop in value, allowing them to make a profit on the assets they borrow. However, if it was as simple as that, wouldn’t the lenders of those – the individuals who actually own them – be likely to make a loss as the result of this practice?
There is, in fact, a little more to it. In order to borrow, short sellers are generally required to pay a fee to their owners. The borrowed stocks are then likely to continue accruing interest until they are returned to the lender. This means that if the person is unable to buy those stocks back quickly (for example, if their value skyrockets), the lender may be able to benefit from the interest.
Is it a Good Idea?
While the technique can be very lucrative and can help traders to reduce the duties they are required to pay, it is also quite a risky strategy. There is a likelihood that the stocks you have borrowed will rise in value which would be great if you owned them. However, because those assets are not truly your own, you can only make a profit if you are able to sell them at a high price and then re-purchase them at a lower price. You may also find yourself paying a considerable amount of interest to the lender in the interim.
However, it’s often the case in many financial practices that when you take sizeable risks, you’re more likely to receive sizeable returns – as long as the cards fall in your favor eventually. If you can afford to take a chance, this strategy may enable you to achieve a significant return.