Understanding Short Selling

If you want to learn about spread betting then you must understand short selling. This is imperative because the whole point about speculation using spread bets is that they offer you total flexibility enabling you to take advantage of whatever way the markets move.

Forget About The Financial Markets - Look at Cricket

The concept of short selling is actually very simple to understand, but it can take some time to sink in because it is the opposite way of thinking to how most people have conducted themselves in the financial markets.

One of the best ways to understand short selling is to use cricket as an example.

England versus India

• You are watching a cricket match with a friend from India
• He boldly states that he fancies his Indian compatriots to score at least 400 runs
• You disagree and so decide to have a bet
• You wager £20 on the fact that India will not make 400 runs during their innings
• Therefore if the Indians score under 400 you'll win £20 from your friend
• If India scores over 400 runs you'll lose £20

Adding More Spice to the Wager

But in the financial markets deals are never executed for a fixed wager as in the example above. Let's expand on the cricket bet.

• You and your friend both decide to have the same bet, you forecasting that India will score under 400 runs, your friend over 400 runs
• Instead of the flat £20 wager you now both bet £1 per run
• Meaning that for every run India scores under 400 you will profit by £1 multiplied by that number
• And conversely for every run that is scored over 400 you will lose £1 multiplied by the number
• You have effectively sold Indian runs short at 400

Three possible outcomes for your short trade:

1. A Winning trade

• India score 325 runs
• 400 (the level at which you went short) - 325 (final score) = 75 runs
• 75 runs x £1 (per run) = £75 profit

2. A Losing Trade

• India score 450 runs
• 400 (the level at which you went short) - 450 (final score) = -50 runs
• -50 runs x £1 (per run) = -£50 loss

3. Breakeven Trade

• India score 400 runs
• 400 (the level at which you went short) - 400 (final score) = 0 runs
• 0 x £1 = no profit/loss

Now translate this cricket example into the stockmarket. Instead of selling Indian cricket runs at 400, sell short Marks & Spencers at £3.50. If M&S declines then the short trade will make money, but it will lose money if the share price moves higher. The profit or loss will simply be multiplied by your stake (pounds per point).