What Is Short Selling?

Normally, when we want to buy, sell or exchange something in the market, we have to physically own it. If you want to sell a phone, for example, you have to actually own it and hold it in your hand before you can sell it. In financial markets, however, there is a mechanism that lets you sell without owning the asset: short selling.

What is short selling in the stock market?

Short selling is an investment or trading strategy in which the trader speculates that the price of a stock or other security will fall in the future. It is an advanced strategy that should only be used by experienced traders and investors.

In a short sale, a position is opened by borrowing shares of a stock or other asset that the investor believes will fall in value. The investor then sells these borrowed shares to buyers willing to pay the market price. Before the borrowed shares have to be returned, the trader is betting that the price will keep falling so they can buy them back at a lower price. The risk of loss on a short sale is theoretically unlimited, because the price of any asset can rise without limit.

Why investors sell short

The most common reasons investors sell short are speculation and hedging. A speculator is betting that the stock price will fall in the future. If they are wrong, they will have to buy the shares back at a higher price and take a loss. Because of the additional risks of using margin in short selling, short positions are usually held for shorter periods and are therefore more likely to be speculative than defensive.

For example, you short a stock at VND 70,000, which means you borrow the share and sell it, receiving VND 70,000. Later, the stock falls to VND 50,000; you pay VND 50,000 to buy it back and return the share you borrowed, so you make a profit of VND 20,000. This is the opposite of buying or investing in an asset, where traders buy because they expect the asset’s price to rise in the future.

What if the stock price rises to VND 100,000 instead? If you buy the share back to return it to the lender, you lose VND 30,000. The profit and risk profile of short selling is therefore the exact opposite of a normal purchase: the trader makes money when the asset’s price falls and loses when it rises.

Investors can also sell short to hedge a long position. For example, if you hold call options (which are long positions), you may want to short against them to lock in profit. Or, if you want to limit losses without actually exiting your long stock position, you can short a stock that is closely related to, or highly correlated with, it.

Net position

A position is the amount of an asset that a trader owns or owes.

When you buy 100 shares, you own 100 shares, so you have a long position of 100 shares, or a +100 share position.

A position is an extension of the idea of “ownership”, because the concept also applies to short selling. When you short 100 shares, you have a short position of 100 shares, or a -100 share position. A negative position means you owe shares, because you are obliged to return the borrowed shares in the future while holding none.

Your net position in an asset is the sum of all your positions in it. For example, you buy 500 shares and later short 200 shares. Your net position is 500 – 200 = 300 shares.

That is the difference between “ownership” and “position”. In the case above, you still own 500 shares but owe 200 shares, so your net position is positive 300 shares.

Your net position shows how a rise or fall in the asset’s price will affect your profit or loss.

When you have a positive net position, you make money when the asset’s price rises and lose when it falls. The larger the net position, the larger the profit when the price rises. A positive net position is also called a net long position.

When you have a negative net position, you make money when the asset’s price falls and lose when it rises. The smaller the net position (the larger the net short), the larger the profit when the price falls. This is also called a net short position.

*Note: in financial English, both “buy” and “long” can mean purchasing, and both “sell” and “short” can mean selling. When talking about positions, however, people only use “long” and “short”, not “buy” and “sell”.

Short selling in the derivatives market

To short a security in the cash market, you must borrow the asset from another trader before you can sell it. In the derivatives market, however, short selling is much simpler: you do not need to own the asset to go short.

For example, when you sell a crude oil forward contract at $90 per barrel, you commit to selling crude oil to the buyer at $90 per barrel at expiration. At the outset, no cash or physical exchange takes place; that only happens at expiration.

These features show that you have a short position in crude oil (because you are obliged to sell in the future) without owning the asset. The profit and risk profile of the short position is unchanged: you make money when the price falls and lose when it rises.

You can go short in the derivatives market very easily with forwards, futures and options. These instruments were created for hedging. For example, if you are a crude oil producer worried that future oil prices will fall and hurt your profits, you sell crude oil futures or forwards so that you can sell at a predetermined price even if oil prices fall in the future.

Is short selling allowed in Vietnam?

If you trade futures, you are probably already very familiar with this. You can short VN30 futures to hedge your stock portfolio, or even to speculate when the market is falling.

In the Vietnamese stock market, this is currently the only asset you can short. Vietnam does not yet allow individuals to short stocks or bonds. For institutional traders, certain market operations may allow them to short some assets.

Another market developing in Vietnam, licensed by the Ministry of Industry and Trade, is the commodity futures market, where investors trade commodity futures in both directions: long and short.

Happy trading!