Traders and investors will finally be allowed to “short” stocks, Philippine Stock Exchange (PSE) CEO Ramon Monzon announced during an interview with Bloomberg TV Philippines.
Mr. Monzon explained that the PSE is currently finalizing the draft rules that will allow short selling. This policy could be implemented as early as the 1st quarter of 2018, Mr. Monzon added.
What is “Short Selling”?
Short Selling is the act of selling a stock that is not owned by the investor and is usually done because of an expectation that the stock price will drop.
If indeed the stock price fell, the investor — who does not own the stock — makes a profit. But if the stock price rose, the investor could incur a loss.
Here’s a more detailed explanation of how “Short Selling”, also called “Shorting” of stocks, is done.
How Short Selling is done
Let’s assume that X Company’s stock is currently trading at P100.00 per share. You believe its stock price will decline in the coming weeks, perhaps due to dismal corporate performance or a generally pessimistic outlook in the market.
You do not own the stock, which is why you cannot sell it. What you do instead is “borrow” the stock from your broker. These stocks may come from the broker’s own inventory or from another client of the broker who owns the stock.
To make our example simpler, let’s say you will just borrow one (1) stock of X. Disregarding any fees and commissions, you can sell this borrowed stock at its current market price of P100.00. You’ll then receive P100.00 from the sale of the borrowed stock.
How to Cover your Short Selling Position
Take note, though, that you sold a stock which you do not own. Sometime in the future, you will have to return this stock to your broker — and this act is known as “closing” or “covering” the short position.
Assuming your bet was correct and the stock price indeed fell to P90.00 per share, what you can do now is buy the stock at a lower price. This enables you to “cover” your short position, meaning, you can now return the stock you owe your broker by buying the stock in the open market.
How to Profit in Short Selling
So how do you make money through short selling?
Remember how much you got when you sold Stock X? One hundred pesos (P100.00).
Now, to return the borrowed stock, you can simply buy the stock in the open market. For how much? At its current price of P90.00.
So you sold the stock for P100.00 and paid only P90.00 to re-acquire it. You’ve closed your short position with a profit of P10.00! (Again, disregarding fees and commissions).
That’s how money is made through short selling. You’ve booked a profit even if you did not own the stock.
You probably now have an idea why some people would do short selling transactions. This is because it’s possible to earn profits even when stock prices are declining or when the market is in a bearish period. Some traders also sell short as an alternative trading strategy or to hedge possible losses from uncertain price fluctuations in the future.
Losses in Short Sales
Of course, shorting stocks is not entirely risk-free.
If your bet was wrong and the stock price, instead of going down, rose to P120.00, you will have to close the position by buying the stock at P120.00.
Using the same example earlier, since you sold it for only P100.00 and you’d buy it at P120.00 to close your position, you now incurred a loss of P20.00.
Now that you’ve understood what it is, are you in favor of short selling transactions in the PSE? Let us know by voting in our poll now!