Short selling dangerous territory for novice investor

A Widely used institutional trading strategy, short selling, has recently come to the attention of individual traders, but without knowing enough about ‘going short’, many investors are taking enormous risks, according to Opes Prime Stockbroking.

The complex investment strategy allows an investor to profit from a falling share price by selling the stock and then buying it back at a lower cost — a viable tactic in a volatile market where investors can pick losers to generate returns.

The biggest risk of this technique is the share price rising rather than falling, meaning the investor would have to cover the cost between the original and higher share prices, and unlike a falling share price, the price can keep rising.

Opes chief operating officer Dean Boyle said a widespread lack of knowledge in this space meant investors did not always understand the risks and regulations involved.

“The lack of reliable information and transparency about short selling will continue to confuse investors, who need to know exactly what they are getting into,” he said.

“Many don’t realise that there are two different techniques for going short; naked short selling and covered short selling.”

Naked short selling occurs when an investor sells a stock, intending to buy it back later at a lower price and profit from the difference.

Covered short selling occurs when an investor purchases shares under a contract that temporarily provides them with legal ownership of the stock, commonly referred to as ‘borrowing stock’.

The investor then sells the shares, with an aim to buy them back at a lower price, thus profiting from the difference upon returning the borrowed securities.

Opes said few investors knew the Australian Stock Exchange rules governing short selling and could face harsh penalties for failed trades.

The short selling specialist firm recommends investors leave it to experienced traders, saying a novice investor shouldn’t even think about going short.