Beating the odds by staying one step ahead

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Beating the odds by staying one step ahead


The stock market is ruled by the maxim “buy low, sell high,” but short selling is a practice that allows the investor to leave a profit by reversing the order: selling high then buying low. How?

Investors sell shares they do not possess with the promise of getting those shares later to honor their sale, based on the presumption that they will be able to acquire the shares for a lower price.

There are two kinds of short selling: naked, which is short selling a stock without first borrowing the stock or ensuring that it can be borrowed, and covered, which means the investor first borrows the stocks from brokerages and other stockholders to sell.

As counterintuitive as the concept may sound to a layman, short selling is by nature a speculative form of investment. Under Korean law, only covered short selling is allowed as naked short selling is deemed too speculative.

Investors engage in “shorting” for one of two reasons: first, to make a profit when the share price drops, and secondly to lessen their losses in a stock they have already invested it but which they expect to drop.

On Nov. 10, the country’s financial regulators lifted a three-month ban on short selling. This had been imposed in August to lessen instability and curtail speculation that ramped up volatility on the local bourse.

The nature of short selling allows for larger profits as future stock prices continue to fall. This makes it popular among profit-centered foreign investors, who make up 80 percent of the short selling transactions in the Korean stock market. As soon as the ban was lifted on Nov. 10, some 380.8 billion won ($340 million) worth of transactions were “shorted,” the largest amount since September of 2008.

“Investors should be aware that any stocks that are overweight compared to their peers in the same category - despite lagging business performance - could become a target of short selling,” said Kang Song-cheol, an analyst at Eugene Investment & Securities.

By Lee Jung-yoon []

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