This month: Marcus Padley
Keep an eye on the stocks that are the favourite target of the short sellers
Custodians hold about $3 trillion worth of stock which they are generally happy to lend out
Each week the Australian Securities and Investments Commission (ASIC) publishes a list of stocks that have been “sold short”. In basic terms it means stocks that have been sold by people who don’t own them.
It is not that easy to genuinely short a stock. You can do something similar through CFD (contract for difference) accounts but I wouldn’t deal with them, and nor would the big players, the hedge funds and the institutions.
Only some brokers offer the facility to set up a shorting account, because it is generally a time-consuming, more risky activity for the same commission and the retail clients who tend to want to do it are generally more demanding of time and resources and require more monitoring than a good old plodder.
To short something you have to contact a broker and ask how much stock is available to borrow. They contact the back office, which contacts one of the big share custodians. Australian custodians hold about $3 trillion worth of stock which they are generally happy to lend out to brokers for a small fee, which is, of course, passed onto the client. With that much idle stock around you can short most things, although when there is a lot of action and volatility the stock that’s available to be borrowed can dry up, and the smaller the stock the less the liquidity and the less stock will be available to borrow.
Once the broker tells you how much stock you can sell short, you pick the amount and they’ll sell that borrowed stock for you. There is a lot more to the detail than that but that’s the bones of it.
When someone shorts a stock they do it in the belief that the price is going to fall, so they sell with the view to buying it back at a later date at a lower price, locking in a profit and returning the borrowed stock.
Of course, sometimes a stock can move in the opposite direction to the shorter’s expectations – that is, it starts going up – and you may see those same people who shorted the stock scrambling back into the market to buy back the amount of stock they shorted to limit their losses as the share price goes higher. This is called “short covering” and is often quoted as an excuse for why a share price is flying up after a recent selldown.
The ASX monitors shorting through its business rules, which require all member firms (brokers) to tag any trade as a short trade if it is a short trade.
Most recently the GFC caused shorting activity to run riot with some significant criticism that, in an atmosphere of fear, short selling was smashing share prices and undermining the integrity and confidence in the US and the global financial system. Both Australia and the US imposed a shorting ban during the GFC while they tried to stabilise the market sell-off.
When they removed the ban the list of stocks that were being shorted began to be published daily, showing how much of the trade related to shorting. The publishing of the list followed the outcry about shorting from regulators and investors alike and met the call for more transparency.
The shorting ban and the extra transparency were not popular with a lot of fund managers, particularly hedge fund managers who made a business out of shorting stocks. Their annoyance makes it apparent that short-selling information levels the playing field against them, which means it adds value to other investors.
Shorters tend to target individual, vulnerable stocks that have already started to drop. They rarely short stable stocks in steady uptrends. It’s like hyenas. They rarely do the initial damage but if they see a wounded animal they swoop in and ultimately they become the problem.
ASIC now publishes the list of most shorted stocks and in the Marcus Today newsletter we analyse which stocks are being targeted and those that have been targeted but are now being bought back. All investors and traders should keep shorting activity in their peripheral vision because it highlights stocks that have an “issue”, are often highly traded, are often volatile and can bounce sharply once the shorting ends.