In an article dated January 22, 2020 in the Jamaica Observer, Mrs Marlene Street Forrest was quoted in the following statement: “the JSE plans to introduce more products and services to the market, including short selling, trading on margin, and options trading — all of which are expected to be implemented in 2020 using the Nasdaq Technology, with short selling coming in the first quarter. We believe that we now have a stable, reliable platform. Based on its reliability, we feel our resources can be otherwise deployed to build out these products and services”.

This was very intriguing to me, so I thought I would examine short selling. This is the practice of borrowing the stock of ABC company and selling it. However, the obvious question would be — don’t you have to give back the stock you borrowed? Why yes, you certainly do.

You know how much was sold so you know exactly how many units you need to buy back, but what you don’t know is the price at which you will be able to purchase the units.

Investors “short” a stock when they believe that the price will fall. Their gamble is that the price will fall, and they will be able to buy it back cheaper and make a profit.

This is not foolproof.

We often hear news reports of “short sellers scrambling to cover their positions”. This occurs when the price is going up — not down — and the short sellers rapidly buy back the stock to reduce their losses on the position.

Short selling has been around for a very long time. It has often been viewed with suspicion as there have been several cases when regulators blamed short sellers for market collapses.

However, it has also proven useful, as they cited the case of Enron when an investor, James Chanos, shorted the stock based on his view that the company’s financial practices seemed questionable, eventually leading to the discovery of tremendous fraud.

Indeed, short sellers have asserted that it is hard work to short a stock, as the loss when buying a stock outright is limited to the purchase price but the potential loss with shorting a stock is limitless.

WHAT IS THE IMPACT OF SHORT SELLING IN THE MARKET?

A large number of short sellers on one stock will cause the price to be depressed very rapidly. The fall in price is generally more pronounced than in regular selling activities.

Of course, the opposite is true when they are “covering”, ie when everyone is buying back the stock the price will rapidly go up. In short, greater volatility in the stock price.

In conclusion, short selling is a risky practice, and even when it is allowed the percentage of short selling as opposed to regular trades is small.

This is due to investors’ awareness of the risks involved, as even if your research indicates that a stock has very poor fundamentals and an even worse outlook, events — such as a merger or a prominent investor purchasing the stock — can drive up the price, immediately putting you in a huge loss position.

Hence, it is not for the faint of heart.

There is a lot more to be said about the topic, but space does not permit. Happy investing!

Yanique Leiba-Ebanks, CFA, FRM, B.S.B.A., is the AVP, pensions & portfolio investments at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at info@sterlingasset.net.jm.