Short selling – what is it?

Short selling is a situation where an investor believes the price of an underlying asset will fall, which results in the investor selling shares that they do not actually own. The purpose of this is to borrow the shares, sell them, and then buy them back at a lower price and return the shares to the borrower.

The return on a short sale is the difference between the higher selling price and the lower repurchase price, less trading costs. 

How is it possible to sell shares that you don’t even own? Quite simply, by borrowing the shares from someone else and paying interest for this action. Shorting is only profitable when the price of the share falls and it is possible to buy it later for less than the price at which it was sold. 

So shorting is actually a form of gambling, where the shorter bets on one share on whether the price of a particular stock will fall and he will make a profit or whether he will lose money. Shorting is not exactly for beginners, although it is quite popular. The shorter must know what he is doing. 

It is worth keeping in mind that shorting is a very risky activity. If you are inexperienced, you can make quite significant losses, because just as there is really no limit to how much a stock can rise, the flip side of the coin is the potential for losses. 

The term shorting comes from the English word “short selling”. In Finnish, we speak of short selling, but this is a bit of a sloppy translation, perhaps a better expression would be overselling. First, you need to know a service provider that enables shorting on their platform. Often, a kind of shorting agreement between the broker and the short seller is required. NordNet, for example, also requires passing a test. The test helps to determine whether the prospective short seller has enough knowledge of what he or she is doing.

In addition to these, you need an account with a credit facility and of course, that account must also have enough collateral so that credit can be granted. 

It is worth considering the possibility that you may have to buy back the shares you sold short at a higher price than the selling price, meaning you will lose money. Shorting is quite a risk, as it is always buying on credit. And there is no upper limit to how much risk the seller can take.    

Can you short anything?

Well, almost anything. The most common way to short stocks is to short stocks, but there are other options as well.

A bear certificate is a derivative and a listed security and is linked to an underlying asset, such as a stock, index or commodity and its price. When the value of the underlying asset increases, the value of the bear certificate decreases. And conversely, when the value of the underlying asset decreases, the value of the bear certificate increases.

Bear certificates are not suitable for long-term investment, but are intended for short-term and rapid trading. By using this product, an investor may lose part or all of their capital. 

Mini-futures are derivative instruments, combining the simplicity and leverage of an option without a predetermined expiration date. Mini-futures consist of the investor’s equity and a debt component. The leverage of a mini-future is provided by the debt component. The advantage of mini-futures is that the investor cannot lose more than he has invested. 

When choosing a suitable mini-future, the investor must first decide on an appropriate Stop Loss level. When the value of the mini-future falls to the Stop Loss level, it expires worthless. In this case, the investor has lost the capital he invested, but no further loss will occur despite the leverage effect. Unlike a bear certificate, a mini-future can be traded for a longer period, due to the fact that the financial contribution remains the same throughout the entire time it is in the investor’s portfolio. 

A warrant is a bit like an option and is also always linked to an underlying asset. It can be a stock or an index, for example, and often has a multiplier. A warrant is the right, not the obligation, to sell the underlying asset at a certain price at a certain time within a few months. 

Shorting in the stock market

In the stock market, you can only get rich by buying and owning stocks. Shorting has unlimited losses and overvalued stocks tend to become even more overvalued. Short selling can be painful if you don’t know what you’re doing, and it’s much simpler to make money by buying stocks.

Is it possible to short cryptos?

Yes, the easiest way to short Bitcoin or other cryptocurrencies is through margin trading. In practice, margin trading refers to the fact that you own only a small portion of the asset you are buying or selling and borrow the rest from somewhere else. In the case of Bitcoin, this usually happens directly on a crypto exchange.

So you borrow Bitcoin from a crypto exchange x times the amount of money you already own, sell it all and then just wait for the price to drop. If the price drops, you buy back Bitcoin or another cryptocurrency of your choice and return the borrowed cryptocurrencies back to the exchange. You can easily do Margin Trading on Binance, for example. 

By simply buying bitcoins, you can only lose as much as you invested in bitcoins even if the price drops to zero. On the other hand, by selling or shorting bitcoins, it is possible to lose an infinite amount of profit. If you sell bitcoins and the price of cryptos rises to a record high, you will lose all the potential profits that you would have made by simply holding your bitcoins.

So it is really important to protect yourself from too large losses. You can achieve this by deciding on a minimum amount, after which you buy back the bitcoins if the price continues to rise. In this case, as a shorter, you will miss out on some profits, but this way you can at least benefit from the price increase to some extent.

On many platforms, such as Coinmotion , it is possible to automatically set limit levels at which you either sell or buy cryptos, and this is a really useful tool for shorting.

Remember that receiving, sending, and storing Bitcoins requires that you have some kind of Bitcoin wallet . This wallet can be a program installed on your computer or mobile phone, or a special security wallet such as a security device or a physical coin wallet.

Also remember an important rule of thumb: you shouldn’t short bitcoins unless you have enough knowledge about what you’re doing. Study the topic carefully before you start shorting. 

Margin account

A margin account can be used to trade all products, as long as the account balance and your own trading experience are in order. A margin account can also maintain a negative balance in one or more currencies. In this case, however, interest will be charged on the negative balance. 

Shorting – threat or opportunity?

Short selling is a bit of a risk. In traditional stock investing, we know that we cannot lose more than the capital we have invested, if this does not include debt. Of course, the value of a share can drop to zero, but it cannot go negative. However, by shorting, it is possible to lose more money than you have invested. 

In shorting, shares are borrowed from another party, meaning the shares are a debt. They are sold and then kept fingers and toes crossed that the price will fall, after which the shares can be bought back at a lower price. Then, the borrowed shares are returned and the profit is set off from the difference between the sale and the purchase.

So that’s the ideal case. However, if something unfortunate happens and the price starts to rise, the poor investor is still in debt to the party from whom the shares were borrowed and has to buy the shares at any price in order to return them.

Sometimes there is a phenomenon called a short squeeze. This makes a pretty significant dent in the wallets of many shorts.

If a stock has already been shorted a lot, it can happen that all the shorters start buying the stock at the same time and the price skyrockets to normal. This creates an unpleasant vicious circle, where the shares have to be bought back at any price in order to return the shares. The price increase can be absolutely insane, and this phenomenon recently happened with GameStop, for example.

Frequently asked questions

Where can you short?

Shorting requires a trading platform that allows trading in shares and where short selling is permitted and enabled. When shorting cryptocurrencies, this can only be done through certain cryptocurrency exchanges. In addition, shorting requires a margin account that provides credit.

Shorting is quite popular on NordNet and it has been made relatively easy there. It is possible to short over 350 stocks on NordNet . Other platforms that allow shorting include Lynx and Danske Bank.

Collateral requirement – ​​what is it?

Margin requirements are when you have to have a certain amount of extra funds in your account when you short sell shares. Different stocks have different margin requirements.

Are there any costs associated with shorting?

Of course, borrowing incurs costs when shorting. Short sales that occur during the same day do not necessarily incur any costs other than the trading costs charged by the service provider. If an investor keeps a position open overnight, a share loan is required, which usually incurs a one-time fee and interest.

The portfolio must therefore have enough products as collateral for the loan to make shorting even possible. The collateral requirement depends on the service provider.

What is shorting a Bear certificate?

Bear certificates are intended for short and fast trading. The downside is that by using this product, an investor can unfortunately lose their capital, either partially or, in the worst case, even completely. 

What is shorting mini futures?

Mini futures consist of the investor’s equity and a debt component. The debt component gives the mini futures its leverage. A very good aspect of mini futures is that the investor cannot make more losses than what he has invested.

What is shorting with a put warrant?

A warrant can be a stock or index, often with a multiplier attached. A warrant is the right to sell the underlying asset at a certain price at a certain time within a few months. However, there is no obligation to do so. 

How is shorting taxed?

From the taxpayer’s perspective, shorting is the transfer of a security. The time of transfer is the same as the time of sale. For tax purposes, the acquisition cost of shares purchased on the same day or the value of shares borrowed on the same day at the time of borrowing may be deducted from the transfer price. The cost of the loan may be deducted as an income-generating expense. 

Taxation example

• shares are sold for 5,000 euros, i.e. the shares are borrowed because they are not owned at the time of sale
• Cost of sale 15 EUR
• At the time of the quote, the fair price of the shares is EUR 4,950, this is the acquisition cost
• Cost to be paid to the borrower, i.e. premium 150 EUR
• For taxation purposes, the purchase price and selling expenses are deducted from the selling price, i.e. EUR 5,000 – EUR 4,950 – EUR 15 = EUR 35
• the capital gain is 35 EUR

When repaying a securities loan:

• the above-mentioned shares have been purchased at a reduced price of EUR 4,000, purchase costs are EUR 15
• the borrowed shares are returned
• At the time of the quote, the value of the shares was EUR 4,950, less the purchase price of EUR 4,000, purchase costs of EUR 15 and expenses of EUR 150.
• the capital gain is 785 EUR