What is ‘shorting’ the market?

by Invstr | Dec 30, 2016

Trading the markets: What is long and short trading?

Trading on a market can be said to be similar to gambling. How? Trading is heavily focused on predictions. When you put down 10 pounds at a bookmaker on a horse, a football team or a tennis player, you are making a prediction on the success or failure of these in any given arena, whether it be a race, individual game or tournament. In the stock market, you are similarly predicting whether a business will perform well or badly over a certain length of time and knowing when to short the market can be a big advantage.

Within the stock market, trades can be broken down into long and short trades. In simple terms, a long trade is where you invest with the intention of profiting from a market that is rising. A short trade is when you invest with the hope of making profit from a market that is falling. To put it into business jargon, a long position is bullish (when markets are rising) and a short position is bearish (when markets are falling). Shorting a stock is the diametric opposite of buying a stock.

The Bear and Bull in front of Frankfurt’s stock exchange – symbolizing the opposite extremes of market movements

How to short the market?

Short selling is the borrowing and selling of a stock, with the hope of buying it back later at a cheaper price. A trader, acting on behalf of themselves, a company or a client, thinks that the price of shares in a company will go down, so in order to make a profit from this prediction, they decide to short them. In short selling, you start by borrowing shares (usually from a broker). You then owe them for borrowing. You (or the broker) sell those shares that you borrowed on the open market (stock market) to other investors for the price they were valued at the time and thus you are short the market.

Let’s use the example of a business and call it Company A. Let’s say Company A’s share price was on the market at $50 a share, but perhaps you see a scandal involving management on the horizon that might reduce the price. You estimate they will drop to $40 a share. You (or the broker) sell the shares borrowed at the market price, (lets say it was 1 share) on the open market. Since at the time they were worth $50 per share, and you have 1 share, you make $50 and it goes into your account. A week goes by and your prediction was right, suddenly Company A is in the headlines for a scandal and investors are losing interest. The share price slides and it eventually get’s down to $40. You then close the short position and buy the same share for $40 on the open market – making a $10 profit. Why did you profit? You sold Company A stock for $50 and bought it back for $40, hence you are up. You do also have to pay a small fee to a broker for providing services.

Show me a real-world example

During the run up to the 2008 financial crisis, few foresaw the damage that America’s housing market would suffer, which came in part as a result of the misselling of loans to customers who could not pay their mortgages. Not only this, but financial institutions were bundling up these loans into complex financial instruments, then selling them on to investors, even though they knew they were ‘subprime’ (essentially – junk). A huge bubble grew as the housing market became overly inflated, and the result, as we now know, was catastrophe. However, some traders recognized the warning signs early enough to make huge profits from shorting the market using instruments called ‘credit-default swaps’, a kind of hedge or insurance policy in case of widespread defaults by mortgage owners.

The Big Short – Michael Lewis’s book on the subprime crisis became a Box Office success

The author Michael Lewis explained the subprime crisis in his book ‘The Big Short: Inside the Doomsday Machine’, which was subsequently made into a film starring Ryan Gosling, Christian Bale, Brad Pitt, Steve Carell and others, as the ‘outsiders’ (based on real people) who saw the crisis coming.

They predicted that the market was heading for a fall which is when you should short the market, which is exactly what short trading involves, hence the film’s title. Barely any investors understood the extent of the problem, because the securities that the banks were trading and selling to investors were rated very highly by ratings agencies, meaning they thought their investments were as safe as houses. The ‘outsiders’ who realized the problem were able to make huge profits by betting against a market which was deemed to be very strong and stable, underpinned by a robust US economy which had been growing well.

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Risk Disclosure:
Invstr is a technology platform, not a registered broker-dealer or investment adviser. Invstr does not offer its own recommendations of any security or provide its own research to any user regarding any security transaction or order.

Please note, investing involves risk and investments may lose value. Past performance does not guarantee future results.

Brokerage services of US-traded securities, including fractional trading, are provided to Invstr users by DriveWealth, LLC a registered broker-dealer and member of FINRA/SIPC. DriveWealth may not establish investment accounts to residents of certain jurisdictions.

DriveWealth provides no tax, legal, or investment advice of any kind, nor does DriveWealth give advice or offer opinions with respect to the nature, potential value, or suitability of any securities transaction or investment strategy. DriveWealth acts as the clearing firm for securities transactions entered on the Invstr mobile platform. DriveWealth is not affiliated with Invstr. Invstr does not participate in DriveWealth’s decision-making.

There is no minimum initial deposit required to open an investing account with DriveWealth. Expenses and Fees associated with the DriveWealth platform in conjunction with Beanstox includes either a monthly membership fee of $4.99 with a commission charge of $0.01 per share* or, in the event the membership fee is not paid, a commission charge of $0.0125 per share applies, subject to a minimum of $2.99 per transaction. There are no monthly minimum fees, or required ongoing minimum account balance. For non-resident aliens, there is a one-time tax verification fee of $5.00 (representing Form W-8BEN pass-through processing cost). View a full list of our fees at http://bit.ly/DWFees

The monthly subscription charge is four dollars and ninety-nine cents (US$4.99) per month plus one cent (US$0.01) per share traded (as examples, for a Transaction of 0.90 shares, the per share traded charge is one cent (US$0.01), and for a Transaction of 1.6 shares, the per share traded charge would be two cents ($0.02), and the quarterly subscription charge is fourteen dollars and ninety-nine cents (US$14.97) every 3 months plus one cent (US$0.01) per share traded. The monthly and quarterly subscription charges may be greater or less depending on additional services offered by a DriveWealth partners as part of the subscription model offering, or based on any subsidies provided by a DriveWealth partner as part of the subscription model offering. For non-resident aliens, there is a one-time tax verification fee of $5.00 (representing Form W-8BEN pass-through processing cost).View a full list of our fees at http://bit.ly/DWFees

This communication is not an offer or solicitation to purchase or sell securities. Investing in securities carries risk, including the loss of principal. Past performance is not indicative of future returns, which may vary. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading. The risks associated with investing in international securities, including US-listed ADRs and ETFs that contain non-US securities include, among others, country/political risk relating to the government in the home country; exchange rate risk if the country's currency is devalued; and inflationary/purchasing power risks if the currency of the home country becomes less valuable as the general level of prices for goods and services rises. Before investing in an ETF, an investor should consider the investment objectives, risks, charges, and expense of the investment company carefully. ETF prospectuses are accessible within the mobile application via a link under each company’s “Description.”

A fractional share is a share of equity ownership that is less than one full share. Fractional share investing has certain limitations and restrictions that investors should understand prior to purchasing fractional shares: ownership of less than one full share does not give the fractional share owner the right to vote on company matters; fractional shares are non-transferrable, meaning they cannot be transferred to another brokerage firm; and fractional share orders will be accepted as market orders only. For more information and details on fractional shares, and any associated limitations or restrictions please visit: https://drivewealth.com/fractional-shares-disclosure

Risk Disclosure:

Invstr is a technology platform, not a registered broker-dealer or investment adviser. Invstr does not offer its own recommendations of any security or provide its own research to any user regarding any security transaction or order.

Please note, investing involves risk and investments may lose value. Past performance does not guarantee future results.

Brokerage services of US-traded securities, including fractional trading, are provided to Invstr users by DriveWealth, LLC a registered broker-dealer and member of FINRA/SIPC. DriveWealth may not establish investment accounts to residents of certain jurisdictions.

DriveWealth provides no tax, legal, or investment advice of any kind, nor does DriveWealth give advice or offer opinions with respect to the nature, potential value, or suitability of any securities transaction or investment strategy. DriveWealth acts as the clearing firm for securities transactions entered on the Invstr mobile platform. DriveWealth is not affiliated with Invstr. Invstr does not participate in DriveWealth’s decision-making.

There is no minimum initial deposit required to open an investing account with DriveWealth. Expenses and Fees associated with the DriveWealth platform in conjunction with Beanstox includes either a monthly membership fee of $4.99 with a commission charge of $0.01 per share* or, in the event the membership fee is not paid, a commission charge of $0.0125 per share applies, subject to a minimum of $2.99 per transaction. There are no monthly minimum fees, or required ongoing minimum account balance. For non-resident aliens, there is a one-time tax verification fee of $5.00 (representing Form W-8BEN pass-through processing cost). View a full list of our fees at http://bit.ly/DWFees

The monthly subscription charge is four dollars and ninety-nine cents (US$4.99) per month plus one cent (US$0.01) per share traded (as examples, for a Transaction of 0.90 shares, the per share traded charge is one cent (US$0.01), and for a Transaction of 1.6 shares, the per share traded charge would be two cents ($0.02), and the quarterly subscription charge is fourteen dollars and ninety-nine cents (US$14.97) every 3 months plus one cent (US$0.01) per share traded. The monthly and quarterly subscription charges may be greater or less depending on additional services offered by a DriveWealth partners as part of the subscription model offering, or based on any subsidies provided by a DriveWealth partner as part of the subscription model offering. For non-resident aliens, there is a one-time tax verification fee of $5.00 (representing Form W-8BEN pass-through processing cost).View a full list of our fees at http://bit.ly/DWFees

This communication is not an offer or solicitation to purchase or sell securities. Investing in securities carries risk, including the loss of principal. Past performance is not indicative of future returns, which may vary. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading. The risks associated with investing in international securities, including US-listed ADRs and ETFs that contain non-US securities include, among others, country/political risk relating to the government in the home country; exchange rate risk if the country's currency is devalued; and inflationary/purchasing power risks if the currency of the home country becomes less valuable as the general level of prices for goods and services rises. Before investing in an ETF, an investor should consider the investment objectives, risks, charges, and expense of the investment company carefully. ETF prospectuses are accessible within the mobile application via a link under each company’s “Description.”

A fractional share is a share of equity ownership that is less than one full share. Fractional share investing has certain limitations and restrictions that investors should understand prior to purchasing fractional shares: ownership of less than one full share does not give the fractional share owner the right to vote on company matters; fractional shares are non-transferrable, meaning they cannot be transferred to another brokerage firm; and fractional share orders will be accepted as market orders only. For more information and details on fractional shares, and any associated limitations or restrictions please visit: https://drivewealth.com/fractional-shares-disclosure

What is ‘shorting’ the market?

Trading the markets: What is long and short trading?

How to short the market?

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