At some point, however, the borrowed stock must be returned to the broker, and so the trader hopes that the price of XYZ will fall, allowing him to repurchase the stock (using the $20,000 proceeds now sitting in his account) at a price below $20 per share. If 1,000 shares can be repurchased, for example, at $15 per share, $15,000 will be taken from the account, leaving a $5,000 profit. Selling stocks short allows traders to profit not only when a stock -- or any other “shortable” security -- drops in price, but it can also be used to limit losses on long positions. For example, a holder of ABC might also create a smaller short position of ABC to offset losses that might occur if the price of ABC starts to drop. There are quite a number of different types of securities that can be sold short, including stocks, indexes and options. While it is not yet permitted in the stock markets of mainland China, there is a way to effectively short not only Chinese-listed stocks, but also entire indexes of Chinese-listed stocks in order to reap profits. So how exactly does short selling work, and how it can be used to make money on China stocks? Is Your Retirement Being Hit With the Government's "Hidden Tax"? Millions of Americans are losing their retirement dreams every year, thanks to the greatest economic conspiracy in history. To make sure you're not one of them, send for this FREE report today. You could collect 2,000% or more by next year… all while protecting the wealth you already have. Read on for more details... Short selling is not available to mainland China investors because margin transactions (wherein a brokerage firm lends funds or securities to its customers) are not yet permitted there. Even so, quite a number of solid Chinese companies that are listed on the yuan-denominated Shangha “A-share” exchange are also listed on the Hong Kong Stock Exchange (“H” shares and “Red Chips”), the New York Stock Exchange and the Nasdaq (“N” shares or ADRs). These markets do allow short sales. In addition to being able to short individual China stocks that are listed on non-mainland exchanges, investors can “get short” on indexes that reflect the performance of a particular group of Chinese stocks. For instance, the FTSE/Xinhua China 25 Index measures the performance of the 25 largest and most liquid Chinese companies listed in Hong Kong (Red Chips and “H” shares), in terms of market capitalization. The Halter China USX Index tracks mainland China companies that have a market capitalization of more than $50 million and that are traded on the NYSE, Nasdaq, or the American Stock Exchange. A good way to short indexes is to use exchange-traded funds (ETFs) that can be bought and sold like individual stocks. For example, the ProShares UltraShort FTSE/Xinhua China 25 (FXP), listed on the American stock exchange, is an ETF that tracks the performance of a portfolio of short positions on stocks contained in that index. If the FTSE/Xinhua China 25 Index declines on a given day, FXP should gain approximately twice as much, on a percentage basis, as any decrease in the index. On the other hand, the iShares FTSE/Xinhua 25 Index ETF tracks a portfolio of long positions of the components of the index. Investors can sell the ETF short if they believe they can profit from a decline in the price of the shares of those 25 mainland companies. The PowerShares Golden Dragon Halter USX China (PGJ) is based on an underlying portfolio of Chinese companies (the Halter USX Index) whose shares are listed in the U.S. Investors seeking to profit from the falling share price of those companies can short sell PGJ just as they would any other stock. Profiting from Short Selling Stocks: Creating Resistance Points and Avoiding Risk Since short sellers must eventually buy back shares in order to return them to the broker (known as “covering” a short position), they, in a sense, provide support for falling prices. When other traders and investors in the market notice the buying activity, they might be motivated to buy the stock, too, pushing prices even higher. Once the stock price has risen sufficiently, short sellers will re-enter the market, creating resistance to further price rises. This movement of stock prices between or through support and resistance points is what creates chart patterns. An inherent risk in short selling that investors new to the strategy should take note of is this: In certain instances, traders that have sold short and perceive that buying interest has come into the market will all rush at the same time to cover their positions before prices rise to the point where they will have to pay a higher price for the stock than the price they received when they originally sold it. The result can be a sharp spike in prices that inevitably attracts more buyers who want to get on board to try to make a quick profit. This is called a “short squeeze.” Although when stocks go down the risk to investors is limited to the difference between the price they paid and zero, the risk to short sellers is theoretically unlimited as there is no telling how high a stock price can go given the right conditions. The short squeeze has been the cause of large financial losses for many investors and traders and remains a risk for those choosing this tactic.
Originally published August 19, 2008. More Articles About Profiting from Short Selling Stocks from Taipan Publishing Group Bankers Short the Orphans' Pot Natural Gas Boom Spells Short-Term Doom for Fertilizer Stocks Short Option Trading: A Profitable Long and a "Priceless" Short Useful Links about Profiting from Short Selling Stocks The Basics Of Short Selling Stocks Short Selling Stocks – When Bad for the Market is Good for You Copyright 2007-2008, The Taipan Publishing Group and Taipan Daily, 808 St. Paul St., Baltimore, MD 21202. All rights reserved. No part of this report may be reproduced or placed on any electronic medium without written permission from the publisher. Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. |
