How Short Selling Opportunities Work

George Soros became known as the man who broke the Bank of England with his impeccable timing of short selling. The renowned forex trader’s short sale of the British pound led to the currency’s massive devaluation in 1992. So much so that today we know the devaluation day as Black Wednesday. Many shorters have made the highest profits off downtrends. The key is to use the asset you understand well and time your short trades precisely. CFDs are one of the most popular shorting instruments. However, remember that no trading strategy, including short selling, can guarantee wins.

CFD Trading: The Opportunities

Contracts for difference (CFDs) are derivative instruments. Their value depends on an underlying asset or basket of assets. However, you do not take ownership of the underlying asset with CFDs. You speculate on the direction of price movement and gain from the accuracy of your analysis. This way, CFD trading enables you to optimise gains from both bullish and bearish markets. CFDs can be used to trade almost all assets, including forex, indices, commodities, cryptos, etc. You do not buy or sell the asset but enter a contract that represents the expected price movement. Therefore, you exchange only the change in the price at the time of closing the position, compared to when you opened it. 

The best part about CFDs is that they are traded on margin. It is a great technique for traders with low capital to gain large market exposure. You borrow money from your broker in the ratio of your capital outlay. For instance, a 1:25 leverage means for every $100, your buying capacity rising to $2,500. The leverage offered differs across brokers and the underlying asset.

Note that amplified purchase capacity translates into higher potential for both gains and losses. Therefore, robust risk management is critical when trading CFDs.

Shorting with CFDs

Short-selling CFDs means purchasing contracts that define a speculated drop in price. Although shorting might seem counterintuitive, it is a powerful technique to increase market participation and the chances of potential gains. You can express the negative sentiment around an asset and capture profits without waiting for the market to turn optimistic. This is great for the markets too, since it improves liquidity and facilitates price discovery.

While traders can take long positions directly (by purchasing the asset) or via derivatives, short selling is mostly done with derivative accounts. CFDs allow you to buy contracts, mentioning the speculated rise or decline in price. Short selling via CFDs is a more streamlined method than traditional shorting, where you follow the long process of borrowing, selling, repurchasing and returning.

To short CFDs, you open a sell trade. When the price reaches the target (your expected decline value), you close the position. An accurate prediction means that the price declines by the expected amount and the difference becomes your gain. You need a comprehensive strategy with fundamental, technical and sentiment analysis to adequately predict the future price direction.

How Does CFD Short Selling Work?

Here’s a step-by-step explanation and example of shorting while trading CFDs:

Open a sell position

To open a position, first choose an asset and identify its future price direction. For example, you choose commodity X, which is currently overvalued at $45 per ounce. Your technical analysis suggests an impending pullback to $40. You enter a contract with the broker for a lot size of 1,000 ounces, which represents $45,000 worth of trade.

Use Leverage to Purchase CFDs

Assume that your broker offers a leverage of 1:10 for the asset under consideration. Therefore, you need $4,500 as margin in your account to open this position

Wait for the Market to Move

After a week, the price of X declines to $40 per ounce, proving your prediction right. Your contract value is now at $40,000.

Close Your Position

Close your position so that you make a profit equivalent to the change in price, i.e., $5,000.

What if the Market Moves in the Opposite Direction?

A prominent risk with short selling is that you can lose more than the amount you invest. To minimise this risk, you need strong risk management measures.

For instance, if the price of X moves from $45 to $50 per ounce, you could lose $5,000, which is $500 more than your total capital outlay. To minimise such losses, you can place a stop loss or even open a long position.

Consider the above example where price of X rises to $50 per ounce, which takes your total loss to $5,000.

If you place a stop loss at $48, your position closes automatically at this price point and your loss comes down to $3,000.

Another technique is to open a position in the opposite direction to hedge against your trade.

Now, if you also open a long position with 4 mini lots of 100 ounces, you could gain $400, which offsets your loss. The total loss comes down to $2,600.

A prominent way to gain expertise on short-selling CFDs is to practise on a demo account. Learn about the markets of your interest and develop a short-selling strategy. Gradually, refine it for diverse market conditions by tracking your performance and learning from successes and failures. Build a steadfast trading psyche to prevent emotions from interfering with rational trading decisions. Keeping a journal can help you gain insights into your strengths and continue to develop techniques that help you strengthen your trading strategy.

To Sum Up

• Short selling allows traders to take advantage of markets trending downwards.
• CFDs are derivative instruments that enable traders to enhance their exposure.
• Trading with margin necessitates risk management.
• Short selling with CFDs does not require traders to own the underlying asset.
• Start with a demo account to develop and refine your short-selling strategy for CFD trading.

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