Cost-related Risks and other Dangers of Short Selling
Short selling is very much unlike going long, which is simply buying a stock and betting for it to grow in value. Also, Guide to Inventing shorting entails a lot of risks that match the potential benefits you can get.
The most commonly cited risk of short selling is the costs and fees that you have to shoulder whenever you do short selling. Fees can accumulate and chip away from your capital and funds. That would mean that whatever gains you got from the trade will be offset by the fees.
To be able to manage such costs, Contract for Difference you have to know what they are first. Read on!
When you want to short sell, you will have to open margin account. And since you are using borrowed money to buy stocks, you will have to shoulder some interest. So better make sure those shoulders are broad.
The interest that you have to pay for every short trade can over time rack up, and that expense can be really heavy especially if you’re tight on budget. They can also grow even further if you keep the position open for an extended period of time.
Stock Borrowing Costs
There are stocks and shares that won’t give out much fuss if you want to borrow them, and then there are shares that are difficult to borrow. They are difficult to borrow because of a plethora of reasons, which can be high short interest, limited float, et cetera.
When you borrow such shares, you have to pay some sort of a ‘difficult-to-borrow’ fee, and this charg can be really huge. This fee is derived from an annualized rate, which can range from a fraction of a percentage to 100 percent of the value of the short trade. It is also pro-rated for the number of days that the short trade is open.
Another downside to this is that the exact amount of the fee cannot be known in advance, since there exist a sizeable fluctuation in the difficult-to-borrow rate that happens on a daily basis—even on an intra-day basis.
Dividends and other payments
You as the short seller are responsible for the dividend payment on the stock you short to the entity from whom the stock has been borrowed.
You will also have to shoulder other payments associated with the stock such as spin-offs, bonuses, and share splits, which can’t all be predicted.
Other Risks Associated with Short Selling
Aside from those cost-related risks, you will also have to shoulder other serious dangers in short selling.
For one, you may encounter some regulatory risks. This is because regulators may at times implement bans on short sales in a specific sector or even across the broad market in order to avoid panic and unwanted selloff pressure.
Such an action can actually result to a hike in stock prices, compelling you as the short seller to cover your position on huge losses. Aside from that, there’s always the risk of a short squeeze, which can also give you devastating losses.