What is the short interest ratio?
We already talked about short interest, expressed as either the net number of shares sold short that are still outstanding (i.e. they have not yet been covered) or as a percentage of the company's float.
Wednesday, March 10, 2010
Short Interest
What is short interest?
The number of shares of a certain company that have been sold short and that are still outstanding (i.e. they haven't been covered yet). This can be expressed as the total number of shares sold short or as a percentage of the float (the float is the number of shares that are available to be traded by the public).
The number of shares of a certain company that have been sold short and that are still outstanding (i.e. they haven't been covered yet). This can be expressed as the total number of shares sold short or as a percentage of the float (the float is the number of shares that are available to be traded by the public).
Tuesday, March 9, 2010
Short Squeeze
What is a short squeeze?
As we have seen, you can borrow shares that you don't have so that you can sell in the market and open a short position. While you have the short position open, you owe those shares to the entity that you borrowed them from (usually some sort of pension or mutual fund that does securities lending). Assuming there is no forced buy-in, you close out the position by eventually (when you decide) buying back to cover, thereby returning the shares to the original lender, netting you either a profit (if the shares declined) or a loss (if the shares rose).
As we have seen, you can borrow shares that you don't have so that you can sell in the market and open a short position. While you have the short position open, you owe those shares to the entity that you borrowed them from (usually some sort of pension or mutual fund that does securities lending). Assuming there is no forced buy-in, you close out the position by eventually (when you decide) buying back to cover, thereby returning the shares to the original lender, netting you either a profit (if the shares declined) or a loss (if the shares rose).
Monday, March 8, 2010
Dividends on shares sold short
What happens to dividends and special distributions when a short position is open?
While a short position is open, there might be a scheduled dividend payment by the corporation to its shareholders or a special distribution of any kind (cash, stock, spin-offs, etc.). In this case, there are three participants, the original shareholder (who lent you their shares), the short seller (you), and the new shareholder (whoever bought the shares you sold short).
While a short position is open, there might be a scheduled dividend payment by the corporation to its shareholders or a special distribution of any kind (cash, stock, spin-offs, etc.). In this case, there are three participants, the original shareholder (who lent you their shares), the short seller (you), and the new shareholder (whoever bought the shares you sold short).
Voting rights on shares sold short
What happens to voting rights for shares that are sold short?
Normally, the shareholder lending out the shares will give up its voting rights to those shares while they are out on loan. This is done so that the voting power is not artificially increased just because there are shares that are borrowed to be sold short. The new shareholder (the one who bought the shares sold short) will have all the voting rights that said shares entitles him/her to. If the original shareholder needs to exercise their voting rights then they would have to call back their shares and finalize the loan so they can use those shares to exercise their voting rights. This is different than dividend rights since those usually go to both the original shareholder even while their shares are out on loan and also to the new shareholder (the one that just bought the shares that were sold short).
Normally, the shareholder lending out the shares will give up its voting rights to those shares while they are out on loan. This is done so that the voting power is not artificially increased just because there are shares that are borrowed to be sold short. The new shareholder (the one who bought the shares sold short) will have all the voting rights that said shares entitles him/her to. If the original shareholder needs to exercise their voting rights then they would have to call back their shares and finalize the loan so they can use those shares to exercise their voting rights. This is different than dividend rights since those usually go to both the original shareholder even while their shares are out on loan and also to the new shareholder (the one that just bought the shares that were sold short).
Capital gains on short positions
Is a profitable short position considered a capital gain?
Just like a long position any profits or losses you make (after you have closed out the position) are considered capital gains or losses and taxable as such. Furthermore, if you are in the US, short selling profits are always considered short term capital gains and taxed as such. Canada does not make this distinction between short and long term capital gains.
Just like a long position any profits or losses you make (after you have closed out the position) are considered capital gains or losses and taxable as such. Furthermore, if you are in the US, short selling profits are always considered short term capital gains and taxed as such. Canada does not make this distinction between short and long term capital gains.
Uptick rule for short selling
What is the uptick rule?
In the past, you couldn't sell short when there was a down tick (i.e. the stock's last move in price was down in price). This was to prevent stocks that were already going down from going down even further because of short sellers. Starting in 2007 this rule was eliminated, although it might be reinstated either fully or in a modified version.
In the past, you couldn't sell short when there was a down tick (i.e. the stock's last move in price was down in price). This was to prevent stocks that were already going down from going down even further because of short sellers. Starting in 2007 this rule was eliminated, although it might be reinstated either fully or in a modified version.
Short Selling Fees
What does my broker get when I sell short?
There is a commision per transaction that goes to your broker (when you open or "sell short" and when you close out or "buy to cover" the position). Your broker also gets additional compensation in the form of rebates by securities lending firms and also as margin interest if you use margin to open or maintain your short position. This is done as follows:
Your broker will have to get the shares for you to sell on the open market so they need to borrow them from a willing lender (this is called Securities lending and is a way for a long-term shareholder to generate income from shares that will remain in the account by lending them out).
There is a commision per transaction that goes to your broker (when you open or "sell short" and when you close out or "buy to cover" the position). Your broker also gets additional compensation in the form of rebates by securities lending firms and also as margin interest if you use margin to open or maintain your short position. This is done as follows:
Your broker will have to get the shares for you to sell on the open market so they need to borrow them from a willing lender (this is called Securities lending and is a way for a long-term shareholder to generate income from shares that will remain in the account by lending them out).
Margin call on a short position
What is a margin call?
When you buy stock on margin (i.e. when your broker lends you money to buy stocks) you need to keep a percentage of the whole position in liquid assets (i.e. cash and marginable securities) to ensure that you will pay off the loan made to you. Since what you buy with the borrowed funds is actually a security that varies in price daily, there is a possibility that the money that was loaned to you was used to buy stocks that declined in price. When this happens, since the outstanding loan is for the same amount as originally and you have started to lose money, there might be a situation where your liquid assets (cash and marginable securities) become less than the minimum required. In this case your broker will issue a margin call, indicating to you that you should deposit additional cash and marginable securities to make up for the shortfall. If you fail to do so, your broker will close out your positions bought on margin at their convenience to recover the original loan made to you.
When you buy stock on margin (i.e. when your broker lends you money to buy stocks) you need to keep a percentage of the whole position in liquid assets (i.e. cash and marginable securities) to ensure that you will pay off the loan made to you. Since what you buy with the borrowed funds is actually a security that varies in price daily, there is a possibility that the money that was loaned to you was used to buy stocks that declined in price. When this happens, since the outstanding loan is for the same amount as originally and you have started to lose money, there might be a situation where your liquid assets (cash and marginable securities) become less than the minimum required. In this case your broker will issue a margin call, indicating to you that you should deposit additional cash and marginable securities to make up for the shortfall. If you fail to do so, your broker will close out your positions bought on margin at their convenience to recover the original loan made to you.
Sunday, March 7, 2010
Forced buy-in (short position)
What is a forced buy-in?
When you initiated your short transaction, there were shares that were borrowed for you to be able to sell in the open market. Sometimes the lender of the shares will need their shares back and will call their shares back. Your broker will try to return said shares from another pool of willing lenders or from its own inventory but sometimes it will be necessary for you to buy back the shares so that they can be returned to the original lender. This is called a "forced buy-in" and is a risk you take on when initiating a short position. It is possible that your whole position or a portion of it is forced to be closed out (regardless of the current profit or loss on it).
When you initiated your short transaction, there were shares that were borrowed for you to be able to sell in the open market. Sometimes the lender of the shares will need their shares back and will call their shares back. Your broker will try to return said shares from another pool of willing lenders or from its own inventory but sometimes it will be necessary for you to buy back the shares so that they can be returned to the original lender. This is called a "forced buy-in" and is a risk you take on when initiating a short position. It is possible that your whole position or a portion of it is forced to be closed out (regardless of the current profit or loss on it).
Closing out a short position
When do I have to close out a short position?
A short position is closed out with a "buy to cover" transaction in most cases when you decide to. The only exceptions are when you are issued a "forced buy-in call" or a margin call that you didn't deposit additional funds into.
A short position is closed out with a "buy to cover" transaction in most cases when you decide to. The only exceptions are when you are issued a "forced buy-in call" or a margin call that you didn't deposit additional funds into.
Short Selling Mechanics
How do I actually short a stock?
Your broker's interface will include an optional similar to "Buy" or "Sell" which will be called something like "Short" or "Sell Short" (to open a short position) along with "Buy to cover" (to close out a short position). This can be done (broker-assisted) over the phone as well, usually for an extra fee.
Your broker's interface will include an optional similar to "Buy" or "Sell" which will be called something like "Short" or "Sell Short" (to open a short position) along with "Buy to cover" (to close out a short position). This can be done (broker-assisted) over the phone as well, usually for an extra fee.
Stocks that can be sold short
Can I short any stock I want to?
Your broker will indicate the restrictions that there are in terms of the stocks that you can short. For the most part, stocks with low stock prices will be difficult to short (or outright impossible to, depending on your broker). Also, there is a daily list of stocks that are "hard to borrow" and these ones might have additional restrictions (such as additional margin requirements).
Your broker will indicate the restrictions that there are in terms of the stocks that you can short. For the most part, stocks with low stock prices will be difficult to short (or outright impossible to, depending on your broker). Also, there is a daily list of stocks that are "hard to borrow" and these ones might have additional restrictions (such as additional margin requirements).
Short Selling Account
What type of account do I need in order to sell a stock short?
There are most likely two types of accounts that your broker will offer you: a cash and a margin account. In order to be able to short stocks you will need to have a margin account. This means that your account will be able to use funds loaned to you (at interest) by your broker. This is necessary for your broker to keep your short position open because you are going to borrow a stock, sell it and receive the proceeds from it but will still need to eventually "cover" this position by buying back to cover.
There are most likely two types of accounts that your broker will offer you: a cash and a margin account. In order to be able to short stocks you will need to have a margin account. This means that your account will be able to use funds loaned to you (at interest) by your broker. This is necessary for your broker to keep your short position open because you are going to borrow a stock, sell it and receive the proceeds from it but will still need to eventually "cover" this position by buying back to cover.
Short Selling Risks
Why do people consider short selling to be riskier than buying ("going long") stocks?
As with most things in the financial markets, the answer is yes and no. Theoretically at least it is true that short selling is inherently riskier. A stock can go higher indefinitely (making your potential loss infinite at least in theory) while it can only go down to zero on the downside (limiting your potential profit to 100%). In reality though, things are a little bit different (and more short selling-friendly) because of the following factors:
As with most things in the financial markets, the answer is yes and no. Theoretically at least it is true that short selling is inherently riskier. A stock can go higher indefinitely (making your potential loss infinite at least in theory) while it can only go down to zero on the downside (limiting your potential profit to 100%). In reality though, things are a little bit different (and more short selling-friendly) because of the following factors:
Short Selling Questions
This article will attempt to answer questions that you may have once you do start selling stocks short. We have already talked about what short selling is conceptually and here we will try to tackle questions regarding the actual mechanics of short selling.
I assume that you have carried out sufficient fundamental and/or technical analysis (depending on your trading style) and that you have already decided to take a short position.
Thursday, March 4, 2010
An introduction to short selling
What is short selling?
Most people when they hear about the stock market think of the old cliche "buy low, sell high" meaning that in order to make money in the stock market one should try to buy a stock at a certain price, then hold for some time and sell later for a higher price. Although that is a good way to net profits in the stock market, that is far from the only way to do so. If you do your research and find a stock that you think will go higher, then what you do is buy it, hold until it appreciates and then sell it at a higher price, pocketing the difference between the buying and selling price. Well what if based on your research (fundamentally or technically based) you have reasonable grounds to believe that a stock will go down? Is there a way to profit when a stock price goes down?
Most people when they hear about the stock market think of the old cliche "buy low, sell high" meaning that in order to make money in the stock market one should try to buy a stock at a certain price, then hold for some time and sell later for a higher price. Although that is a good way to net profits in the stock market, that is far from the only way to do so. If you do your research and find a stock that you think will go higher, then what you do is buy it, hold until it appreciates and then sell it at a higher price, pocketing the difference between the buying and selling price. Well what if based on your research (fundamentally or technically based) you have reasonable grounds to believe that a stock will go down? Is there a way to profit when a stock price goes down?
Wednesday, March 3, 2010
Trading Volume
What is trading volume and why is it important?
Technical analysts consider only two pieces of information relevant to determine the potential future price behaviour of a security (and therefore, potential trading strategies for it): the stock price itself and its trading volume both analysed over time. As you can see, trading volume is a very important technical tool and whether you base your strategies around fundamental or technical analysis it is imperative that you understand and interpret what it might reveal about a potential stock or any other financial instrument that you might be about to invest in or trade.
Technical analysts consider only two pieces of information relevant to determine the potential future price behaviour of a security (and therefore, potential trading strategies for it): the stock price itself and its trading volume both analysed over time. As you can see, trading volume is a very important technical tool and whether you base your strategies around fundamental or technical analysis it is imperative that you understand and interpret what it might reveal about a potential stock or any other financial instrument that you might be about to invest in or trade.
Monday, March 1, 2010
Bid-ask spread
What is the bid-ask spread?
You have done your analysis, have some money ready to be put to work and have decided to buy a stock because you have reasonable expectations that it will go up eventually netting you a profit.
So you go to your broker's interface and locate the stock that you intend to buy (by using its ticker symbol or looking it up) and decide to get a quote on it. Immediately you notice that there is a lot of information (last trade, change from last trading day's close, volume, etc) but most strikingly you notice that for the stock you are looking at you have three prices: the price that the stock last traded at, a bid and an ask.
You have done your analysis, have some money ready to be put to work and have decided to buy a stock because you have reasonable expectations that it will go up eventually netting you a profit.
So you go to your broker's interface and locate the stock that you intend to buy (by using its ticker symbol or looking it up) and decide to get a quote on it. Immediately you notice that there is a lot of information (last trade, change from last trading day's close, volume, etc) but most strikingly you notice that for the stock you are looking at you have three prices: the price that the stock last traded at, a bid and an ask.
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