Investing is usually associated with buying stocks and other securities – it seems intuitive for most people, which is why most of us would rather experience a bull market than a bear market environment. However, investors ought to be aware that they can also benefit from falling prices. Find out how in this article.
In this article you will learn:
- What is a short position?
- Which markets can be shorted?
- When may you consider a short position?
Investing is usually associated with buying stocks and other securities – it seems intuitive for most people, which is why most of us would rather experience a bull market than a bear market environment. However, investors ought to be aware that they can also benefit from falling prices. Markets tend to fluctuate - asset prices might be increasing one day followed by a price drop the next day. Therefore, one should always remember that traders are able to go either long or short, thus gaining when prices are either rising or falling.
Buying vs Selling
It would be reasonable to go long if you expect the price of a selected instrument to go up. In this scenario, an investor takes a long position or, in other words, buys the instrument. Should the price of this instrument advance (according to the initial plan), the investor would reap the benefits from the trade as the position becomes profitable.
Source: xStation5
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
On the other hand, if an investor expects the price of a selected instrument to go down, he or she might take a short position or, in other words, sell the instrument. Should the price of this instrument fall (according to the initial plan), the trade would be profitable.
Source: xStation5
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
As far as stock markets are concerned, buying securities is easy to understand – investors bet that certain companies or whole markets would advance. In most cases, this has been a sound strategy from the long term perspective as the global economy expands. Nevertheless, market instabilities occur as well and the availability of short selling enables investors to apply different, more appropriate strategies. As it was already mentioned above, markets also tend to go down. If you anticipate a correction or just believe that some asset prices will fall, short selling is a strategy that enables you to earn profits under such circumstances – it is as simple as that.
Here it should be stressed that an investor does not necessarily need to own an asset in order to conduct short selling – the word “sell” might be misleading for some beginner traders. Nowadays investors are able to sell something even if they do not own the asset, thus opening a short position. Contracts for difference (CFDs) are a financial instrument that allows such trading. Similarly, if you buy a CFD on a stock, you do not actually own the underlying instrument (a stock) – you just bet that its price would go up in the future.
The purpose of short selling
Shorting certain securities serves mostly speculative purposes as traders believe that the price would for some reason go down. If market participants suspect that the price of a certain asset (a stock, a stock market index, a commodity etc) would go down, they open short positions in order to benefit from falling prices. As explained above, there is no need to own the underlying instrument while trading CFDs. Also, investors may sometimes want to go short in order to mitigate their risk as opening a short position hedges against potential losses in an owned investment – we’ll present an appropriate example afterwards.
Markets where you can trade short positions
In case of CFDs (contracts for differences) traders never own an underlying asset. Therefore, any contract that is available in the XTB offer can be subject to a short position! This includes commodities such as Gold or Oil, indices such as DE30 or US100, as well as currency pairs and single stocks.
When to consider a short transaction
Traders usually base their decisions either on technical or fundamental analysis. While there are various strategies under those broad names, let’s discuss a few basic examples.
Fundamental analysis - traders often consider short positions when they see the market as being too expensive. Examples might include above-average price to earnings ratio for index like US500 or a bull market on OIL that has been longer than on average in the past. By opening a short position traders express their view that an overheated market will normalise in the future.
Technical analysis - most technical analysis tools are equally good at spotting buying and selling opportunities. Let’s consider a downward channel. A test of the upper limit in this channel can be seen as a signal of bearish trend continuation. Traders opening a short position express their view that trend indeed continues.
Source: xStation5
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
In this example, a test of upper limit in a downward channel heralded a continuation of price declines of SILVER.
Examples of how to open a short transaction
Example 1 - DE30
To begin with, it should be noted that XTB’s trading platform provides access to a broad array of financial instruments. Let’s touch on some major markets that enable various short selling strategies.
Starting from indices, traders might want to bet that certain indices will go up or down. If you expect that a stock market index is set to decline, you can short an index CFD. In order to open a short position, a trader should choose an appropriate volume and click the “sell” button - an instant execution is the quickest way to place any trade. The red button always shows a price at which you can enter a short position.
In order to short a stock market index, you can click the “sell” button, thus placing an order. Obviously you do not need to own any underlying instrument while trading CFDs. Source: xStation5
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
Anybody interested in short selling does not need to own large amounts of money, as CFDs enable leverage trading. Therefore, traders can easily choose the volume that they can afford. One should also remember that using leverage could potentially amplify either gains or losses. However, if you’re not quite sure what indices are, we would first recommend reading our article titled “Indices Trading – what is a stock market index?”
Example 2 - Gold
Gold investing is often associated with bars and coins, but at XTB traders can trade GOLD CFDs also when they expect Gold prices to decline.
If this is what you suspect because - for example - in your opinion previous price gains were too dynamic, you are able to short the Gold market. Once you open a short position, you’re going to benefit from falling gold prices, but you will lose if prices increase.
Traders are able to open short positions directly through the “Market Watch” tab in the xStation5 platform. In order to do that, you should just click the “sell” button.
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
Example 3 - EURUSD
Currency pairs are sometimes misleading for the novice traders, but they are actually great examples of how short positions are no different from long positions in anything bar their direction. Imagine you see strong industrial output data from Germany and you think this will help the euro versus the dollar. If this is the case, you expect EURUSD to go up (more dollars for one euro) and you can open a long position on EURUSD CFD. But what if next month the industrial report is very weak and you expect the euro to decline versus the dollar? You then expect EURUSD to go down (less dollars for one euro) and you can open a short position on EURUSD CFD. These positions work exactly in the same way!
Short selling is also possible thanks to the Click&Trade button that can be found in the top-left corner in the xStation5 platform.
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
Hedging through short selling
Short trading is a very powerful tool, as it enables investors to hedge their portfolios as well. This makes short selling extremely useful during the periods of uncertainty that are often accompanied by rapid market swings. Let’s consider two quick examples:
Example 1 – selling an index CFD as a hedge
Let’s imagine that an investor owns several blue chip stocks from Germany. The portfolio is worth roughly 30,000 EUR. An investor suspects that a market correction is looming, yet he or she does not want to sell those stocks. In order to hedge the portfolio, investors might use a CFD contract for index reflecting 30 largest German stocks. Opening a short position is going to effectively neutralise the investor's long position. In this case an investor might want to use an index calculator to assess the size of a position needed to hedge the portfolio: 0.08 lot corresponds to around 30,000 EUR. Now, in case stocks from the portfolio go down, the investor should benefit from the CFD short position. As a rule of thumb, the stock portfolio will be hedged.
Source: xStation 5
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
Example 2 – selling a CFD on a stock as a hedge
Let’s imagine that an investor owns 10 shares of the Volkswagen stock listed on the German stock exchange. The car producer is going to release its quarterly report and the investor suspects that the company’s results might significantly miss analysts’ expectations due to global chip shortages – in such a scenario Volkswagen stock price is expected to tumble. In order to mitigate the risk, the investor might either sell their shares or short the stock thus hedging against the downside risk (e.g. by using stock CFDs). Shorting the stock is going to effectively neutralise the investor’s position. Should Volkswagen miss earnings and sales expectations, the value of shares owned by the investor would probably fall, but at the same time the investor's short position would turn profitable.
To summarise, short positions on CFDs are a mirror image of long positions. If you expect the price of an index, stock or commodity to decline, you can open a short position - you do not need to own the asset to trade on price declines!
Source: xStation5
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
Summary
Short trading is a popular strategy among many investors, as it enables them to benefit from falling prices - and markets fall quite often indeed. Nowadays, there is a wide range of opportunities in terms of short selling as retail investors have gained access to a variety of financial instruments, including CFDs. Therefore, one should be aware of this solution – whenever you suspect that the price would fall, you can easily place a short trade.
