Short order in trading: what is it?

The practice of opening short positions has become the focus of attention of a wide audience against the backdrop of the coronavirus pandemic. Critics argue that short positions lead to market manipulation and are often used to purposefully destroy firms.

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What is a short position?

A short position is a method that many traders use to make quick money, as they can increase their capital size in the hope of making additional profits.

Let’s consider a simple example. Let’s say William is eyeing Shard Industries , which is currently trading at $75. He firmly believes that the value of the shares will inevitably fall, so he decides to open a short position on the stock exchange . He borrows 150 eligible shares from the broker for a total of $11,250 and enters a short position, offering those shares to another buyer. Now William can only wait.

Two weeks later, Shard Industries publishes quarterly reports – the worst in its history. Combined with other factors, this sends the stock down 40% to $45.

William decides to buy back the shares in order to return them to the broker. Given that they cost him $6,750, he was left with a profit of $4,500. However, commissions and fees are likely to eat into this amount a little.

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Regulations against Short Position Trading

Although short trading was not invented yesterday, this technique is increasingly being criticized, especially against the backdrop of the current panic in the markets. In response to the coronavirus pandemic, regulators around the world have taken measures aimed at limiting the profits of traders in a situation of falling markets.

European countries hardest hit by the virus, such as Italy, Spain and France, have been hastily imposing restrictions on short positions for companies deemed most vulnerable. And at the end of March, it was decided to extend this ban for another three months for all shares listed on the stock exchange.

However, not all states followed suit and began to prohibit short positions for trading. For example, Great Britain, which during the crisis of 2008 actively introduced such bans, this time decided not to resort to them. As a result, hedge funds and ordinary traders were free to short positions on the stock exchange.

This approach to short positions caused controversy between the Financial Conduct Authority ( FCA ) and the Bank of England. According to the first organization, the markets should remain open, and short positions can help them work uniformly. As the new chairman of the Board of the Bank of England, Andrew Bailey, in turn, those who take short positions are unlikely to act in the interests of the British economy.

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Risk of short trading

Of course, trading short in trading does not guarantee profit. The stock market can go up as well as down, and there is always the chance of losing a lot of money.

Let’s go back to the example of William, who borrowed 150 shares of Shard Industries at $75 and then decided to go short. Another scenario is also possible: despite the price drop to $45, he got greedy and decided to wait for an even bigger drop. And then the Shard company announced that it would be bought out by another large company. This unexpectedly led to the explosive growth of the company’s shares to the level of $100 per share.

Now William needs to buy back the shares and return them to the broker. He ends up buying them at $95 per share and spending $14,250, or $3,000 more than the original cost. Now William is probably very sorry that he decided to open a short position.

So, we have clarified what short positions are. A short position is a tool that can be used both as a way of aggressive speculation and as a means of portfolio diversification. Obviously, there will be further turbulence in the markets in the coming months, which means that the debate over the possibilities of short trading will not subside.