What Goes On Behind The Scenes?

As soon as most people are introduced to short selling the question 'how can you sell something you don't own' is asked. But how can you buy and sell cricket runs with your friend? You can't own runs and you can't touch them!

• There are two answers to this question, the simple one and the complex one
• It is a waste of time to try and understand the complex administration of short selling because it will not help you make money
• Instead start to view whatever you're trading, whether Barclay's shares, the FTSE 100 index or gold in its most basic form, as a simple number
• The short seller will make money if the number decreases from the point that he initiates the trade and lose money if it rises

Concentrate your time on simply understanding the mathematics of the profit and loss. When a trader is offered the ability to go short a share, option or future via a spread bet, let the broker handle the mechanics behind the trade. Your job is to make money; the spread betting broker's job is to provide you with the tools and set-up to enable you to do this.

Caught Short

There are dangers in short selling, as there are with buying a share.

• Let us say you sold Safeway short at 250p because you thought it was performing poorly and that its results would be dismal
• But just before the results were due the US supermarket chain WalMart put in a bid for Safeway, and the shares rocketed to 350p
• You were wrong. You now have to cover your short bet by buying the Safeway trade back
• Theoretically there is no limit on how high a share can rise, so theoretically there is no limit on your ultimate exposure.

The risk of takeover is always a scare tactic used by people who discourage short selling and while this is true there are two points a short seller has to realise.

1. Just how often do surprise takeovers happen?
2. What about profits warnings where share prices often drop by 25% or more in a flash. There are in our opinion just as many potential risks to the buyer of shares as there are to the short seller.

Short Selling & Short Term Trading

Sort selling is basically a strategy of the speculator. A lot of money has been made since the peak of stock prices back in the years 2000/2001 but these traders are not 'short and hold' types (if that phrase exists), rather they can be viewed as hit and run traders. They sell the stock short and look to cover it certainly within a month or so, and maybe just days or even hours.

• Short sellers also know that in bear markets the hardest and sharpest movements tend to come in the form of rising prices, so called bear market rallies
• Just look at the movements of Wall Street from October 2002 onwards and you'll see that stocks and indexes can easily move up 10-20% in a matter of days, even though the overall trend remains down
• Bottom line when short selling, take you profits and don't overstay your welcome

Summary of Short Selling

• Short selling is a relatively simple concept
• It is also an important part of any spread bet trader's toolbox for it means that they can not only profit from bearish moves in stocks, options or indexes, but can also use some of these instruments to effectively hedge or take protection over investments that will suffer in declining markets