Short selling or ‘shorting’ is an investment technique that allows an investor to profit on a stock or commodity falling in value. Although short selling may not always be the best strategy, especially for those with a small amount of capital to invest, it has its uses. But can you legally short shares in the UK?
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What is shorting shares?
A typical investment scenario entails making a profit by selling shares for more than their original cost or losing money by selling them for less than their original cost.
Shorting is a different investment strategy. It involves an investor borrowing and selling shares they do not actually own in the hope of repurchasing them at a lower price at a later date.
The process is simple. An investor borrows shares from a brokerage or another investor (usually for a fee). They then sell the stocks immediately, hoping that the price will fall after the sale. The aim is to buy them back cheaply when the price falls and then return them to the rightful owner, pocketing the difference.
In the UK, investors can also short shares through what is known as leveraged trading. This involves speculating or betting on market price movements rather than borrowing shares.
Investors can do this by:
- Spread betting – where they place a bet on which direction they think the stock market will move.
- CFD (contract for difference) trading – where they buy a contract to exchange the difference between a stock’s closing and opening price.
Is shorting shares legal in the UK?
Yes. Shorting shares is entirely legal in the UK.
However, shorting shares has been banned in the country at various times in history. For example, during the 2008 financial crisis, the government imposed a temporary ban on short selling to protect local markets from the volatility it causes.
Several countries in Europe and around the world also banned short selling early last year, at the height of the Covid-19 crisis. The majority of these bans have since been lifted.
Who can short shares in the UK?
Anybody with a share dealing account can short positions in a company’s shares.
When it comes to shorting shares, however, hedge funds tend to be the main players.
Why is shorting shares often controversial?
Shorting shares has frequently sparked controversy, despite the fact that it is legal.
This is especially true when it involves targeting companies in a weak financial position that could go bust. The idea of profiting from the failure of a business in which shareholders and creditors will suffer losses simply does not sit well with many people.
Indeed, it was these sentiments that sparked the GameStop frenzy in the United States.
A large group of traders banded together to support and buy the video game company’s stock, essentially raising its value and hurting hedge funds that had taken large short positions in the company.
How does shorting benefit the financial market?
Though controversial, short selling can sometimes be beneficial to the market.
It can help to identify companies that are in trouble, preventing investors from losing money by investing in them. Shorting can also help identify companies with shares that are overpriced.
Firms that are shorting shares must disclose their positions in UK-listed firms to the Financial Conduct Authority (FCA).
A private share notification is required when the net short position of an investment firm accounts for more than 0.1% of the issued share capital of the company and again at each 0.1% threshold thereafter.
When the net position reaches 0.5%, a public notification is required. Firms must make a public notification again at each 0.1% threshold above 0.5%.
Investors can view the public disclosure of the short positions of big investors in the ‘short positions daily update’ published on the FCA website.
Should you short shares?
Although shorting shares is legal in the UK, it’s an extremely risky strategy. The losses can be significant if you make the wrong call. It’s perhaps in the best interest of novice investors to stay away from this extremely risky strategy.
Such investors would likely be better off focusing on the less risky strategy of buying stock and holding it for the long term.