Fri 16 July 2010
Whilst stockmarkets tend to perform well over time, there are often short periods when individual shares, currencies or stockmarkets as a whole, decline. For example, the tech-bubble burst in 2000, Sterling’s collapse from €1.52 and $2.11 in 2007 and the recent credit crunch induced FTSE 100 collapse, led by the banking sector.
Traditional investing aims at profiting from a rising price (referred to as 'going long') and then selling when you perceive the share price to be overvalued. You then wait for the share price to decline to present you with the next buying opportunity. Historically, it has been difficult for private investors who have spotted a weakness in a market, or company, to take advantage of the anticipated fall.
The method of benefiting from a falling share price or market is known as 'shorting', 'going short' or 'short selling', and there are now a range of methods by which investors can take advantage of such a view.
What is short selling?
Short selling is now a widely used technique to profit from a falling market, or price. In its simplest form, you agree to sell an asset which you do not own at the current market price, with the hope you can buy it back at a much lower price; the difference being your profit.
This is a perfectly legal and frequently used market transaction. It is commonly achieved by using derivatives (a financial instrument with its value linked to the price movement of an underlying asset).
How can you access short selling?
Whilst short selling can prove an effective investment strategy, or hedging tool for an existing portfolio, it is essential to be fully aware of the risks involved. This is just a brief introduction, and alone does not give sufficient information to enable you to invest.
Absolute Return Funds
Absolute return funds are a relatively new breed of fund which aim to deliver a profit regardless of the direction of the stockmarket. The fund manager has the freedom to invest in a variety of investments (including derivatives) to go 'long' or 'short' depending on their view. These funds rely entirely on the skill of the manager to make the right decision – if the wrong decisions are made they can lose money even in a rising market.
To learn more about absolute return funds and how you could potentially benefit, please request our free guide to absolute return funds. You can also view a list of absolute return funds available through the Vantage Service.
Look at market fluctuations as your friend rather than your enemy.
Warren Buffett
Financial Spread Betting & Contracts for Difference (CFDs)
Financial Spread Betting and Contracts for Difference (CFDs) are increasingly popular ways to go long or short on a wide variety of investments. They give you access to: currencies, commodities, sectors, bonds, stockmarket indices, Options and company shares from around the globe.
By initially depositing a small percentage of the transaction value (often just 5%), investors speculate by taking a view that a price will rise, or fall, and profit if the price of underlying asset moves in their favour. They are high risk investments because you can lose more money than you invest if you make the wrong decision, which is why they should only be used by experienced investors who understand the risks involved.
Both are currently free of UK Stamp Duty and Spread Betting is currently free of capital gains tax, although tax laws can change and depend on personal circumstances. Further information can be found on our dedicated website, HL Markets; alternatively please request a free guide to CFDs or Financial Spread Betting.
Exchange Traded Funds (ETFs)
ETFs can be bought just like a share as they trade on a stock exchange. A select range of ETFs enable you to go short. There is a narrower range of markets available with ETFs when compared to CFDs or Spread Betting.
Different types of ETFs will have varying levels of risk depending on the volatility of the underlying asset(s) and structure of the ETF. Be aware that the leveraged funds are much more risky. In addition many ETFs use futures contracts rather than physically holding the underlying assets and this introduces a further risk known as counterparty risk. Please see the Risks of ETFs section for further details.
Most ETFs are eligible for both the Vantage ISA and SIPP. This means some shorting products are available within a tax wrapper. You can also view a list of ETFs available through Hargreaves Lansdown. ETFs are currently exempt of UK Stamp Duty (tax laws are subject to change).
Covered Warrants
Covered Warrants offer investors the option to short some listed equities, indices, currencies and commodities. The price movements of a Covered Warrant magnify those of the underlying asset(s).
Unlike ETFs, Covered Warrants have a limited life span ranging from six months up to two years. A Covered Warrant’s expiry date can have an effect on its volatility. Any loss on Covered Warrants is limited to the amount that you invest; however, the value of your investment can quickly fall depending on the performance of the underlying asset.
Owing to their complexity, Covered Warrants cannot be held within an ISA. They can, however, be held in the Vantage SIPP and the Vantage Fund and Share Account. Covered Warrants are currently exempt of UK Stamp Duty (tax laws are subject to change).
Other financial instruments used for shorting
This is not an exhaustive list and other financial instruments such as Options, Futures and Hedge Funds will also provide access to shorting.
Paul Dimambro
Head of HL Markets
