What is short selling? One of the benefits of trading CFDs (Contracts for Difference) is that you can go short (sell with the hope that the value of your contracts will fall) as well as go long (buy with the hope that that the value of your investment will go up).
However, trading CFDs gives you the ability to trade financial instruments without owning them. So how can you sell something that you don’t own?
Let’s say that it’s raining outside and you don’t have an umbrella. As you need to run an errand, you borrow an umbrella from your colleague. In the elevator there is a woman in a designer suit who doesn’t have an umbrella, and asks if she can buy yours. You agree, and sell it to her for $40. Here you have sold something that you didn’t own.
Not to worry – you run to the shops and find your colleague’s umbrella on sale for $15. You buy the umbrella and return it to your colleague, having made a $25 profit.
Short selling CFDs is similar – if you decide to go short on share CFDs, your CFD provider will lend you the shares for a deposit that is just a fraction of their worth. You open a trade by selling these share CFDs, and when their value has dropped, you close the position by buying the shares and realise a profit on the difference in price.
Short selling CFDs example
Singapore Airlines is quoted at 10.30/10.32, and you go short on 1,000 shares at 10.30. You pay a deposit of 10%, or $1,030 ($10.30 x 1,000 x 0.10 = $1,030).
So in theory, you have just sold 1,000 share CFDs that you didn’t own. This would bring your balance of share CFDs to -1,000.
A few days later and the price of Singapore Airlines’ shares has dropped to 9.50. If you had been going long, you would have made a loss. However, as you were going short, you have made a gross profit of $0.80 per share.
You decide to close the position by buying back the 1,000 share CFDs you sold – this would bring you balance of share CFDs back to 0, and give you a gross profit of $800 (gross profit = $10.30 – $9.50 = $0.80 x 1,000 shares = $800).
Why sell short?
The main benefit of short-selling CFDs is that this enables you to make a profit in any market. When the market is going up you make a profit by buying a financial instrument and selling it at a higher price. Going short means you can make a profit by selling a financial instrument and buying it back at a lower price.
This is something that can be difficult to do with conventional share trading and brokers can charge extra fees for the service. CFD providers charge lower commissions than share brokers, with commissions starting at just 0.1%.
Unlike conventional share trading, going short with CFDs is just as easy as going long and most CFD providers allow you to go short on a range of financial instruments, including over 7,000 global shares, Forex pairs, indices, commodities and options.