The best short seller cost control comes from playing the right stock at the right time! But to do that, timing is the secret cost control short sellers use to keep fees, commissions, other carrying charges plus dividend expenses as low as possible. By getting that done while lining up prices with volumes on quality target stocks, short sellers can produce greater profits.
What you learn:
The lesson makes you aware that short sellers must get and do many things right including controlling fee, commission, carrying or dividend costs timed with share price movements and volumes. Knowing that informs you how important parts of stock markets function.
Frequently Asked Questions about Short seller cost control
How do short sellers control costs?
Short sellers prioritize cost control by minimizing fees, commissions, carrying costs, and dividend expenses. To achieve this goal, they carefully time their entry and exit.
While promoting the target as an excellent overvalued short sale opportunity, they closely monitor the falling share price, trading volumes, and running costs while keeping their research current.
When the short sale is successful, they must time the covering or closing buyback to ensure the lowest costs and the highest profit without triggering a short squeeze.
Is short selling more profitable?
Well-researched and executed short sales can yield spectacular profits!
The best short sellers produce research uncovering fraud, financial mischief, or other significant vulnerabilities to make a convincing case for lower-value shares.
They drive prices down by convincing or panicking shareholders into selling and getting others to join the short-selling.
In addition to finding overvalued shares, the best short sellers use sound research, effective promotion, excellent timing, sharp execution, well-managed costs, and, finally, critically timing the covering buyback.
Despite the intricacies and heightened risks, when all the elements align, well-executed short sales can deliver breathtaking results!
How do short sellers drive prices down?
Short sellers use a two-fold strategy to drive down prices.
First, they sell quietly to establish their opening position.
Second, they publicly expose the overvalued stock and promote their case loudly.
When short sellers convince or scare shareholders to sell, the volume spikes as the price falls. Opportunistic short sellers can rush in and force prices lower when fraud or financial mismanagement is exposed.
Although short sellers must manage many complex factors, success comes down to timing and execution. Timing affects when to establish a position, execute trades, and cover before a short trade becomes overcrowded and triggers a short squeeze!
What is a short squeeze?
A short squeeze is a buying panic when short sellers rush to cover. When that demand rush exceeds supply, the price quickly spirals higher until the buying peaks.
In a short squeeze, short-sale profits quickly disappear, and losses grow with the carnage continuing until the shorts are out!
Crowded trades or overplayed positions cause most short squeezes but can also happen when short sellers target the wrong stock.
Wrong targets can be stocks pushed by FOMO or buyer greed to wildly overvalued prices in waves of buying the next big thing. For such market darlings without fraud or financial issues, markets have carried irrational prices for years! Wise investors do not short market darlings.
How Short Sellers Drive Prices Down
Short sellers can affect market prices using five powerful price-moving tools while managing their covering risk:
1. Initial Selling Pressure
2. Negative Market Sentiment
3. Self-Fulfilling Downward Spiral
4. Triggering Stop-Loss Orders
5. Margin Calls on Long Positions
The Short Seller Covering Risk
When short sellers eventually buy back shares to cover their stock loan, all goes well if they can buy at a lower, profitable price. Large-scale short covering can lead to a short squeeze, causing a price spike and financial disaster for short-sellers.
Short-Selling Consequences
Short sellers drive prices down primarily through increased supply and negative market perception. They hope to start a cycle of selling pressure, triggering stop-loss orders and margin calls to increase the price decline. However, while short selling can accelerate price declines, it is not the only influence on a stock's price.
Looking For Short-Selling Profits
We are discussing costs because they are a significant factor in short-selling profits. The following puts costs in some context. Investors often seek ways to maximize returns, and short-selling is one strategy that can offer high rewards. Depending on various factors, short-term strategies can sometimes be more profitable than other strategies. The intricacies of short-selling unlock risks and those potential profits.
Potential for Profit
1. High Returns in Bear Markets
Short-selling can yield substantial returns when stock prices fall. It may outperform traditional long positions in a bear market, offering savvy investors a lucrative opportunity.
2. Leverage
Short sellers often use margin to amplify their gains. Margin is debt, borrowing money from your brokerage by putting up more collateral. It can significantly boost profits if the market moves in their favor. However, it's a double-edged sword, as it also magnifies losses.
Risks Involved
1. Huge Losses
Get it wrong, and short-sellers can lose more than they bet on the play. Unlike going long, where the maximum loss is the initial investment, short-selling risks huge losses. That can happen because short-sellers face significant financial exposure since a stock's price can rise indefinitely.
2. Margin Calls
Utilizing leverage means that if the stock price increases, short sellers might be required to add more funds to their accounts or close their positions at a loss. Forced buybacks can produce a cascade of losses at unfavorable prices.
3. Borrowing Costs
Short sellers must pay interest on borrowed stocks and may incur additional fees if the stock is difficult to borrow. Like all costs, this eats into potential profits.
Market Conditions
1. Market Trends
Short-selling can be riskier and less profitable in a generally rising market (bull market). Conversely, it can be an excellent way to capitalize on falling prices during market downturns.
2. Volatility
High market volatility can increase the potential for profit and the risk of substantial losses. Short-sellers need to be adept at navigating volatile conditions to succeed.
Skill and Timing
1. Expertise Required
Successful short-selling demands a deep understanding of market trends, company fundamentals, and technical analysis. It's a strategy that challenges even the most experienced investors, making it engaging and rewarding for those with the expertise. Not the faint-hearted or inexperienced.
2. Timing
Precise timing is crucial. Entering or exiting a position too early or late can significantly impact returns. Short-sellers must be adept at predicting market movements and acting swiftly.
Costs
1. Transaction Costs
Frequent trading means higher transaction costs. More trading costs reduce overall profitability. It's essential to factor in these costs when evaluating potential returns.
2. Short Interest
High short interest in a stock can lead to a short squeeze, where rising prices force short sellers to buy back shares at higher prices, exacerbating losses. Short sellers must carefully manage this risk.
Costs and Profits Conclusion
An identified overvalued stock or a declining market can be very profitable for short-sellers. However, it takes more than that. Short-selling carries substantial risks and costs. Its profitability relative to other strategies depends on market conditions, timing, and the investor's expertise. Short-selling is not inherently more profitable than other forms of investing and requires careful consideration and responsible risk management.
For those willing to take on the risks and who have the necessary expertise, short-selling can be a powerful tool in their investment arsenal. However, take this strategy seriously and only approach it with a thorough understanding of the potential pitfalls.
Short sellers need the right costs and prices
All costs and share prices matter when selling short. Those costs include transaction costs and fees, selling share price realized when selling short, and finally the share price when buying to close out or cover the short position. Costs are critical, timing is the secret.
Time control is the best cost control
Controlling the timing of their short play is the biggest cost control that short sellers have. As a result, most short sellers end their plays in a few days or a week but most often well under a month. However, there are epic exceptions such as when giant hedge funds tackle a large player they think is overvalued, mismanaged or conducting some illegal or questionable business. That conflict can produce some spectacular business drama! And such shows can carry on for months or, in a few exceptional displays of ego, years!
When such epic battles unfold and get carried on long enough, those titanic conflicts can make the mainstream news. At such times, it can seem business news should be included with the entertainment news. But when such wars are under way, few investors want to go anywhere near. Staying away is the best cost control for the individual investor!
Costs, all costs
Someone new to short selling soon feels they carry a sign that says, “I sell short, charge me a fee!” It seems everyone has a few more fees for any short seller. Those fees can include borrowing, carrying, transaction, administration, management, and commission costs! It can seem like a fee for this a fee for that!
Short fees include interest costs or the equivalent because, after all the sold stock is borrowed and the lending broker needs to make it worth their while. In addition, all transaction costs and of course any dividends that must be paid are another real cost of short selling.
Any short seller must be aware of all possible costs before ever considering a short sale. In addition, short sellers must manage the daily costs which pile on each day they carry their short seller position.
And remember, before starting the short sale, the short seller has to first find and borrow stock before selling it. That means, for a cost, getting at least a willing lender of stock. Just like the short seller, they are only going to come into the play to make money as is everyone else that aids or facilitates the transaction. The short seller is responsible for paying them all.
The big dividend bite.
Short sellers considering making a play on a dividend paying company have some significant costs to consider. They must be aware that should the shorted stock pay a dividend, all costs associated with paying that dividend, and the dividend itself, comes from the short seller. So should any dividends be due while the short position remains open, the short seller must pay.
And there is no opportunity to later recover the sunk cost of paying any dividends. The dividend paid by the company being shorted goes to the owner of the shares that are sold by the short seller.
After all, those are borrowed shares, so the short seller must pay the dividend to the owner of the account that the shares were borrowed from. That payment goes through the broker, for a fee. In all costs, the short seller stands on their own. Short selling can get expensive!
Dividends are one factor that can become a very significant cost to a short seller. This is especially true if the timing the short selling is significantly off. Worse yet, if multiple dividend payments are needed.
Recall, the brokers-loaned stock that was borrowed from another account. The owner of that stock still has the right to, expects, and gets, their dividend payments without any interruption or risk.
The cost of those dividend payments immediately comes directly from the account of the short seller on the due date. In cases when the account has insufficient cash, it forces the sale of other assets or any unrelated shares in order to produce the cash.
Share prices and the price history
The share price, both when short selling to open the position and when buying back the shares to close the position, must be in the short seller’s favor, to make a profit. Before opening the position, the shares of the target company must be trading at prices significantly above what the short seller believes is the real or true value of the shares.
The short seller needs a buyer for what they believe to be an overvalued stock. That means any viable short candidates must have relatively high ‘overvalued’ stock prices. The price history or chart may also tell a short seller the market knowns and has discounted the shares or that the opportunity remains. It is an important judgement call.
In practical terms the potential for both substantial and downward price movement must be in place. That means never considering low-priced stocks as potential shorts. Even when bad news can drop such a stock price considerably lower.
Obviously, if the market knows or anticipates bad news, the price will already be discounted. In such circumstances, the price has limited further downside potential. That makes such a stock an unattractive short target. The wise short seller would move on and look for a short target that offers greater short profit potential.
Trading volumes and history matter
There has to be a significant and continuing volume of shares being exchanged for any potential short target to be attractive. In particular, short have no interest in considering a stock with low trading volumes.
When opening a short position by selling the high priced shares, or when buying back to cover with lower priced shares and close the position, the trading volumes must be there.
Should volume dry up at either end of the short sale transaction, there is an immediate and big pricing/cost problem. Forcing either transaction by chasing the market down to sell, or up to buy and close the position, can quickly devour any profits. In worst case scenarios, profit quickly turns to unlimited running losses.
Should the short seller be wrong about a cost or price factor, the transaction can become an unlimited financial horror story and money loser. Buying back the stock and repaying the loan provides the only way out. When a short seller gets it wrong, it can get ugly expensive!
Size matters when we talk cost
Ironically shares of big companies with large trading volumes are usually, “Easy to Borrow”, sell and buy back to cover, all a relatively low associated costs. Smaller companies or those with lower trading volumes are inevitably, “Hard to Borrow” at higher cost, carry more margin risk and often don’t work particularly well as profit making shorts.
The lesson that teaches short sellers is to stay in the main stream current because the market in shallow water may leave you stuck on the high cost shoals without profit. Or worse, the financial torture of an ugly short squeeze in a thinly traded stock. Never ever short here!
The short squeeze
The short squeeze is the worst case that occurs when short sellers miscalculate and the share price does not drop, but rises instead. Those short plays are on the wrong side making the wrong move. Prices that run against shorts can quickly build upward momentum.
The stock price can significantly and rapidly rise as it moves against the short seller. Dividend costs just add to the financial pain. Should traders know, realize or believe a large short position is wrong or ‘off-side’, a buying frenzy can be unleashed! It can get ugly. But like watching a car crash, it is hard to look away!
And opportunistic traders can quickly descend like sharks on wounded prey knowing that the short must add more buying to cover their short position. The short cover buying, ironically, adds to the financial pain of those buyers! That short covering buying pressure pushes prices higher until the short are all out.
Price escalation can ruin a short play
Another short selling cost risk is the unanticipated price escalation. Most often not related to the short selling activity but other news or market action. As a result, dramatic and rapid escalation in share prices can occur. That can force a short seller to cover to stop their losses. In one of the bizarre facts of market life, their buying adds to their own financial pain because all buying pushes the prices higher yet.
When short sellers are trying to close a short position and stock prices are rising, the short seller is experiencing the pain of a short squeeze. The classic short squeeze is not pretty for the short seller but can be party time for aggressive the long investors willing to trade on the short seller pain!
In such cases, company management often declares victory and claims the good guys won as they do some gloating. In the case of a losing short seller, few tears get shed for shorts that lose their bets.
Be careful out there
About all shorts can do for cost control is to get the play right and time their execution flawlessly. When they do time their trades well, it can be wonderfully profitable. But without being reasonably correct about timing, or having a significant price drop or sufficient trading volumes, shorts can be in trouble. Such short selling transactions can be very expensive and financially unpleasant exercises.
Get it all right and taking a short position can quickly produce dramatic and considerable profits. As I have said before, short selling is not a strategy for a beginner. Don’t learn about investing by taking any short positions under any circumstances.
Question Answered!
For cost control, short sellers have limited choices but have to select the right target, at the right time and execute with skill to profits. Missing on any of those gets financially ugly! The lesson makes you aware that short sellers must get many things right including controlling fee, commission, carrying or dividend costs timed with share price movements and volumes. Knowing that informs you how important parts of stock markets function.
Lesson takeaways,
Short seller cost control, includes:
The best short seller cost control comes from playing the right stock at the right time! Timing is the cost control secret of short sellers that keep costs of fees, commissions, other carrying charges or dividend expenses as low as possible. Get that done and line up prices with volumes to produce a short selling profit.
Other lessons related to:
Short seller cost control
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Costs drive stock position size
Thinking investors grow wealth
Sorting US & Canadian stock markets
Financial statement numbers exposed
Comments and questions welcome
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Lesson links to:
Short story shorting stocks:
Short selling stock explained Lesson 1
Short selling improves markets Lesson 2
Short selling improves companies Lesson 3
9 Short seller facts align Lesson 4
Making money selling short Lesson 5
Shorting stocks has risks Lesson 6
Who’s selling your stock? Lesson 7
Short seller skill sophistication knowledge Lesson 8
Short seller cost control Lesson 9
Short selling has rules Lesson 10
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Short selling has rules
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