Shorts Squeezed
Posted on July 25, 2008
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In recent days much has been written about “short selling”, in particular banking shares on both sides of the market. A quick reminder: short selling is being allowed to “borrow” shares not owned and betting they are likely to fall in price. When the price does fall buying them at the lower price and giving them back to the broker. The profit is in the price you sold at (ie the opening trade) and the price you buy at (ie the closing trade). This is one of the most popular “Ask Anna” questions and I am always trying to find different ways of explaining the concept. My latest attempt is given at the bottom of this post.
Problems with short selling by largely secretive hedge funds has led to the financial regulators in the UK insisting on large short positions being declared. In the US last week’s SEC’s announcement of a possible Banking Committee hearing and vague new emergency restrictions against “naked short selling” led the Dow Jones to have rallied a total of 700 points on the week. However, one rally does not a summer make - even if oil also duly obliged by falling to $128, and has continued to do so.
Text of email received from Daniel:
Hello Anna,
Short selling … A stupid question
Short-selling means selling shares which you do not actually own, but instead borrowing them from another party to “sell” on the market.
It is said that large volumes of short selling can drive a company’s share price down significantly…
How, please? … the shares are borrowed and eventually returned to the shares owner??? …
I borrow shares from a bank, sell them (the buyer never get hold of the shares), buy them back and return them to the bank …
The sale cannot actually occur as the shares are borrowed and still owned by the shares holder… or does a sale actually occur?…
How the market maker knows about it? Anyway, nothing has been bought or sold …
How can this affect the financial market (driving the underwritten price to force selling at a discount); as no sale really happens?
Does short selling through spread betting or CFD can affect the market as well, in the same way? I would say “no” as in this case it is only a bet on the price movement of a share… correct?
Now, how FSA new rules (short-selling the shares of a company conducting a rights issue have to reveal their activities…) can prevent any “damage” to the issuers in question? revealed or not, the short-selling does occur anyway …
Thank you for your time Anna
Regards
Daniel
My answer to Daniel was as follows:
The point you are missing is that whilst the shares are indeed “borrowed” from another client within the brokerage the short seller physically sells the shares and his/her account debited accordingly. The short seller hopes to buy back the shares at a lower price and pocket the profit. To put it into context and perhaps more simple terms: when you trade long your opening position is a buy and your closing position is a sell. When you trade short your opening position is a sell and your closing position is a buy. The only difference with short selling is that you are selling something you do not own.
As a short seller you are responsible to the original owner for any dividend so if a dividend is declared whilst you have sold the shares you will be liable to pay that to the real owner.
If the prices rises above the price you sold you will be forced to buy the shares back at the higher price in order to return them to their rightful owner.
Spread betting and cfd’s are based on derivatives and trading is not based on physical shares.
Hope the above helps.
Regards.
Anna
End of Answer
Is The Oil Bubble Ready To Pop?
Posted on June 26, 2008
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I cannot believe I haven’t posted since May 30th when I predicted an imminent fall in the price of oil. Whilst this has not happened (yet) our world leaders have been rushing around desperately trying to deflate the commodity bubble and thereby increasing their own carbon footprints by about 1000%. I still believe the commodity market is overheated and due for a major correction. Market tops and bottoms are characterized by excessive volatility - great for day traders but nightmare for longer term investors.
In the meantime even the great Soros himself has confirmed that, in his opinion, a large element of the oil price is speculative and that we can expect a sharp pull back. In addition once politicians begin questioning how the price of oil has effectively decoupled from the fundamentals of supply and demand we can expect something to happen.
Last month’s data from the CFTC on futures contracts did show that at one point a speculative “short” position on oil jumped 11pc suggesting that some of the big boys, at least, suspect the oil boom is overdone and ready for a fall.
However, this is somewhat contradicted by the December 2016 futures which have been rocketing to fresh highs, in some cases accelerating at an even faster rate than spot prices. My personal view is still the same - I believe prices will fall but only this time I will remind myself of my own advice and not try to predict a market top.
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Posted on May 30, 2008
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The loud banging of stable doors can be heard throughout the financial markets as leading regulators on both sides of the Atlantic begin to investigate “possible market manipulation” of the oil market. These are the same regulators who were asleep at the wheel last year when the credit markets went into freefall (apologies for mixing my metaphors!!).
Market manipulation aside a quick look at the oil charts does indicate an imminent reversal (the same is true for both gold and silver). Oil weekly shows a two bar reversal with the monthly giving the strongest signal yet that the price is about to fall - a gapped up evening star. Gold and silver both show bearish engulfing candles on the week so expect prices to fall here too. This does not necessarily signal an immediate rush back into equity markets which are still very volatile (great for day traders!). What it does reveal is financial markets in transition.
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