Expert guide: Should you be shorting stocks in the current market?
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Director and Portfolio Manager at Cyan Investment Management, Dean Fergie explains what is involved in shorting a stock and whether it is wise in the current market.
Explain what it means to short a stock?
Shorting a stock is essentially backing that its share price will decrease. The way to do so is to borrow a stock, pay the owner interest and sell it into the market. At a later date you then buy it back on the market and return it to the investor that you borrowed it from – in the hope of making a profit.
Why do investors short stocks?
Investors short stocks if they think they are overvalued – for example, if they can borrow shares at 40c and sell them back at 20c then there are significant gains to be had.
That being said, buying the stock back can cost more than you bought it.
Volatility provides risk and opportunity.
Some investors say shorting is good to negate the market risk, but in my opinion it is a bit of a falsehood – you can still get both sides of the trade wrong.
Just because you short Qantas, doesn’t mean your long investment in Virgin will pay off.
There are brokers that have facilities to borrow stock, but there are stocks you can’t short simply because they don’t go into a pool where they are lent out.
I guess what you are trying to do is second-guess market momentum – but if I was running a fund and had to short stuff, I would have lost a fortune in this market because it is so bullish.
Why do you prefer to take a long position?
We want to back, support and help businesses that are doing the right things rather than take advantage of those that are not doing well.
It’s a completely different mindset.
When it comes to shorting you can lose a lot more than 100 pc of your money – whereas if you go long then you can get more than 100pc back.
What stocks are most likely to be shorted?
The best candidates are those where momentum is strong.
At the moment investors are very bullish and at times don’t seem to think about underlying value – there are companies capped at 100M and have almost no value.
But for me, as a fundamental investor, I’m not willing to give companies the benefit of the doubt.
How long can you hold a stock to short it?
There is a lot of shorting at the big end of town because there is so much stock available but what you’ll also find is that big index funds can add a bit of income to their holdings by lending them out.
When the availability of stock is larger, it is more likely to be shorted.
Dean Fergie is the Director and Portfolio Manager for Cyan Investment Management.
Dean has more than 25 years experience in the funds management industry covering all major asset classes. Over the past 15 years he has specialised in small cap industrial ASX listed companies. He holds formal qualifications including Master of Applied Finance and Bachelor of Engineering (Civil). Dean has lectured for the Securities Institute of Australia and is a Graduate of the Australian Institute of Company Directors.