CFD Trading & Short Selling - What You Need To Know
Categories: CFD Trading
Tags: CFD trading Malaysia CFD trading Short Selling
Publish date: 2023-5-11
Short selling is a trading strategy that has been around for many years, but it is often misunderstood or even viewed as unethical by some people. The definition of short selling, its relationship to CFD trading, its mechanics, advantages, and disadvantages will all be covered in this article.
Table of Contents
- General Introduction
- Can CFDs be sold short?
- What is Short Selling?
- How does Short Selling work?
- What are the Benefits of Short Selling?
- What are the Risks of Short Selling?
- What Is a CFD Sell Position Example?
- How to Sell a CFD Instrument with FXCM
- Conclusion
General Introduction
CFD trading and short selling are both popular trading strategies used by investors in financial markets.
CFD (Contract for Difference) trading is a method of trading financial instruments that involves speculating on the price movement of an underlying asset, such as stocks, commodities, or currencies. CFD trading allows investors to trade on margin, which means they only need to deposit a small percentage of the total value of the trade. This leverage magnifies potential gains, but it also increases potential losses.
Short selling, on the other hand, is a strategy used by investors to profit from a decline in the price of an asset. In a short sale, an investor borrows shares of a stock or other asset and sells them, hoping to buy them back at a lower price and pocket the difference. Short selling can be risky, as losses can be unlimited if the price of the asset continues to rise.
Can CFDs be sold short?
CFD trading can also involve short selling, as investors can take a short position on an underlying asset through a CFD. This means that they can profit from a decline in the price of the asset without actually owning it. However, as with short selling, there are risks involved, and investors should be aware of the potential for losses.
The ability of CFDs to engage in short selling is one of the key factors contributing to their popularity. Investors now have the chance to profit when markets are declining thanks to this. This function serves as a hedging technique for some long-term investors to safeguard their gains.
What is Short Selling?
Investors utilise the short-selling or short sale strategy to try and profit from declining asset values. Traders commonly short shares, but the approach can also be used with other assets like commodities, cryptocurrencies, indexes, and foreign exchange.
When traders have doubts about an asset's short-term performance, they frequently sell short. For instance, a trader may open a short sell position to try and profit from a probable share price decrease if they thought Tesla had a high value relative to other automakers.
Another way to protect against price declines is through shorting. Therefore, a trader could open a position in the opposite direction from the original position if they thought their portfolio might lose some value and wanted to hedge against possible losses.
Short selling is commonly used in the stock market, but it can also be used in other financial markets such as commodities, currencies, and bonds.
How does Short Selling work?
Short selling involves borrowing shares of a stock or other asset from a broker, then selling them on the open market. The investor must then buy back the same number of shares at a later time to return them to the broker. If the price of the asset has gone down in the meantime, the investor will make a profit on the difference between the original selling price and the lower buying price.
For example, let's say that an investor borrows 100 shares of a company's stock and sells them for $50 per share, bringing in a total of $5,000. A week later, the price of the stock drops to $40 per share. The investor then buys 100 shares back for a total of $4,000 and returns them to the broker. The investor has made a profit of $1,000 on the transaction.
Using derivative products like CFDs is another option to profit from an asset's price decline. With this trading strategy, you can trade an asset's price changes without actually owning the asset. Therefore, a trader need only open a sell position with a broker when they anticipate that the price of an asset will decline. Traders frequently like this technique of selling because it is simpler than physically buying an object.
What are the Benefits of Short Selling?
Short selling can be a useful strategy for investors for several reasons. First, it allows investors to profit from a decline in the price of an asset, which can be especially valuable in a bear market when many stocks are losing value. Second, short selling can be used as a hedge against other investments. For example, if an investor owns a large amount of stock in a particular industry, they may want to short another stock in the same industry to protect themselves against a downturn in that sector.
Finally, short selling can also be a valuable tool for market analysis. When investors short a stock, they are essentially betting against the company, which can provide valuable information about the company's financial health and prospects.
What are the Risks of Short Selling?
While short selling can be a profitable strategy, it can also be extremely risky. One of the biggest risks is that losses can be unlimited if the price of the asset continues to rise. In our previous example, if the price of the stock had gone up to $60 instead of down to $40, the investor would have had to buy back the shares for $6,000, resulting in a loss of $1,000.
Another risk of short selling is that it can be subject to manipulation. Short sellers are often accused of spreading negative rumors or false information about a company in order to drive down the price of the stock and make a profit. This is sometimes called "short and distort" and is considered illegal.
What Is a CFD Sell Position Example?
A winning sell example:
Let's imagine you think Apple's stock is overpriced and is headed for a decline. As a result, you choose to short the company.
The cost of a corporation share is $140. You choose to open a position to sell 100 shares, raising the total amount that can be traded to $14,000 as a result. After one day, Apple's share price has dropped from $140 per share to $126, a 5% decrease.
Because you anticipated the decline correctly, you ended up making $14 per share, or a total profit of $1,400.
A losing sell example:
You think that Amazon's share price is now trading above its intrinsic worth and that a retreat is imminent. As a result, you initiate a short position.
The cost of the company's shares is $155. Your position is opened to sell 100 shares, bringing the total amount that can be traded to $15,500. Amazon’s stock price has increased by 3% since the previous day, from $155 per share to $159.65.
You ultimately lost $4.65 per share as the stock price increased, for a total loss of $465.
How to Sell a CFD Instrument with FXCM
- Open a Live Account by submitting the online application.
- Fund your account and place your first trade.
- Explore trading options for CFDs on cryptocurrencies, equities/shares, indices, commodities, and precious metals.
Get a feel for the platform by signing up for a Free Practice Account.
Conclusion
Investors who seek to make money from a fall in an asset's price can benefit from short selling.
However, it is important to remember that short selling comes with risks, including unlimited losses and the potential for manipulation or short squeezes. As with any investment strategy, it is important to carefully consider the risks and benefits before making any investment decisions.
To mitigate the risks associated with short selling, investors can use a variety of strategies. One common approach is to set stop-loss orders, which automatically close out the short position if the price of the asset rises above a certain level. This can help limit potential losses in case of a short squeeze.
Another strategy is to pair short positions with long positions in other assets. This can help balance out the risk of the portfolio and reduce the overall exposure to short selling.
It is also important for investors to carefully research the companies they are shorting and to avoid spreading false information or rumors that could manipulate the market. In some cases, short selling may be prohibited or restricted by regulators, so it is important to check the rules in your particular jurisdiction.
In conclusion, short selling is a powerful tool for investors who want to profit from a decline in the price of an asset. However, it is important to be aware of the risks and to use strategies to mitigate those risks. As with any investment strategy, careful research and analysis are key to success in short selling.
FAQ
Is shorting same as CFD trading?
Spread betting or CFD trading are other ways to engage in short selling. Both are derivatives, which let you make predictions about how the price of the underlying asset will change without actually owning it.
Is CFD trading good for beginners?
For new traders, CFD trading may be appealing, but there is a high risk involved. Beginner traders should first confirm that they are familiar with the fundamentals of CFD trading, such as leverage, margin, and stop-loss orders. Selecting a reliable and licensed CFD broker is also essential.
What is the difference between short and long in CFD?
If you buy or take a long position, you might have to pay interest on overnight positions. If you decide to take a short position (or sell), interest will be paid to you if the position is held overnight.
When am I required to buy back a short position?
How long you can keep a short position for is not subject to any set rules or restrictions. There can be a limit on how long a short position can remain open with some brokers. When markets are in trouble, ad hoc limits on short selling may occasionally be put in place in an effort to restore stability to the financial system.
[Disclaimer] The articles above are purely personal opinions and are not intended to be investment advice. Only for the purpose of mutual learning and sharing. There is no express or implied warranty regarding the accuracy or completeness of the above-mentioned information. Anyone who relies on the information, ideas, or data contained in this article does so entirely at their own risk.