Is short selling a dying art?

Darren Sinden

In the short term it may be that short-sellers have taken a pragmatic stance and are waiting for the market to show them that it has topped out rather than fruitlessly and expensively trying to pick that point for themselves.

MetaTrader 5 advances its hedging functionality

One of the principal attractions of margin trading is the ability to trade on the short side just as easily as you can on the long side.

Cash settled Contracts for Difference (CFDs) mean that end-users no longer have to worry about making or taking delivery of the underlying instruments and margin trading providers can extoll the virtues of trading the other 50% of the market that long-only traders are missing out on.

A question worth debating is whether shorting the market is a dying art and if it is should margin trading business be worried?

We ask those questions because it seems that short interest in the world’s largest equity markets is on the decline. S&P reported in November that short interest in the S&P 500 stocks had fallen to just 3.42% among the shares outstanding in the top 500 US companies, and that this figure was lower than the 3.95% seen in mid-March when global equity markets sold off sharply.

The S&P 500 index is up 13.5% year to date and some 1400 points above the low it posted on March 23rd, which we might have thought would have provided short-sellers with an obvious opportunity and yet that doesn’t appear to be the case.

In fact, looking at the long term data we find that the short interest for the average S&P 500, stock as a percentage of market cap, is at its lowest levels for 16 years which is part of long term decline from peaks of short interest posted in 2008.

Certainly it is the case that market capitalisations have risen substantially since 2008, therefore it’s natural that this figure would reduce over time, however, the decline has been much more marked than can be explained by natural wastage alone.

Of course, it’s also true to say that traders now have a much wider choice of instruments through which to take a short position and they are no longer confined to individual stocks themselves.

There is an increasing number of equity options contracts, inverse ETFs and similar products to tempt them.

Meanwhile, at larger margin trading houses, such as IG Group and CMC Markets, equity index trading now accounts for the largest part of their revenues, suggesting that client trading tastes and appetites have changed.

Let’s not forget as well, that until the sharp sell-off in March, we were in the midst of an 11-year long bull market in US equities, and though we moved briefly into bear market territory, that move was unwound at breakneck speed and markets rallied to new all-time highs later in the year.

Indeed November was the best month for US equity indices for decades and in some case the best performing month ever.

So in the short term at least it may be that short-sellers have taken a pragmatic stance and are waiting for the market to show them that it has topped out rather than fruitlessly and expensively trying to pick that point for themselves.

Bank of America highlighted today that flows into equities over the past four weeks had reached $115bn, betting against that kind of incoming tide just doesn’t make sense.

So it seems more likely that the bears have gone into hibernation early this year and that they will be back, but perhaps not until there is a thaw in the markets.

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