Shorting CFDs

Being ever the optimist may work in life but in financial trading it can be worthwhile to sometimes be a pessimist.

CFDs and CFD trading gives you the opportunity to take short positions just as easy as long positions. Shorting is usually available through your CFD provider on the leading shares of the leading exchanges and usually trades can be open ended i.e no timescale is stipulated before a trade is forced to be closed. Short trading is popular amongst sophisticated traders for 2 main reasons, speculation and hedging.

Speculation

If you have a view that XYZ Inc. is ready to fall in price you can take a short trade i.e sell the stock with a view to buying it back at a lower price and profit from the difference between your selling and buying price. If the stock subsequently rises then the trade would be showing a loss.

Hedging

Hedging works in the same way as speculation but with a hedged trade you would already have exposure to the stock or instrument you are wishing to short.

For example you may already hold 2000 XYZ Inc. physical shares and for various reasons may not want to liquidate your position, but also don’t want to see your investment fall in value, taking out a short CFD trade for 2000 XYZ or less will either fully or part hedge your above shareholding so any downfall in the price would show a profit on the short trade.

This method of hedging is mainly used for locking into a profit as you can see that if your shares rose in value any profits would be offset by the losses incurred on the short trade.

Strategies

Short trading is an extremely useful facility that should be considered, traders have double the market opportunities and history dictates that when markets are falling they usually do so quicker than when markets rise thus many short term opportunities could be made available.

A popular strategy when shorting is to take advantage of potential falls in share prices due to dividend announcements. Usually when a company makes its dividend announcement (ex dividend) the share price will fall by approx the amount of the dividend being declared. The reason behind this is any purchases made after the announcement will not be entitled to the current dividend thus the price is discounted to make allowances for this. Short sellers can place short trades to speculate on the price decreasing but should look for a decrease more than the specified dividend amount. Short positions aren’t entitled to the dividend as you have technically sold your shares so this will have to be paid out of the CFD account to compensate and make it a fair trade. In conclusion the above strategy only works if the share price drops further than the announced dividend due to market conditions and potential inactivity in the stock.

Points to Consider

  • Short trades may not be available on all CFDs
  • Dividends have to be paid by the short seller as your position has SOLD so no dividend entitlement.
  • Short CFD trades are the opposite of long positions so with long positions you pay interest or funding and with short positions you usually accrue interest on your account.
  • You do not buy a short position you open a trade by selling and then close the position by buying.