Short Selling With CFDs | Guide from Eightcap

Short selling with CFDs refers to a specific way in which you can trade/speculate on price declines across markets, without owning any underlying assets or shares. 

Essentially, it is for traders who believe an asset's price will fall. In this scenario, they want to sell an asset at a high price and then potentially buy it back at a lower price later. 

This is achieved through a Contract for Difference (CFD), which is a derivative contract between you and a broker that tracks the price of an asset. 

In this guide from Eightcap, we’ll provide a step-by-step breakdown of how short selling with CFDs works, including a numerical example so you can learn how to trade in falling markets. 

We’ll also use examples of short selling from different asset classes, the mechanics involved in short selling, and outline the risks involved, so you can decide whether short selling with CFDs is right for you. 

How short selling with CFDs works step-by-step

Short selling with CFDs can occur when you think an asset price will fall. Let’s use EUR/USD as an example, as it's the most traded currency pair in the Forex market. 

If you think EUR/USD will fall, you can open a short position (i.e., sell a CFD at the current price). You do not own this underlying asset, but you are entering a derivative contract with a broker based on EUR/USD’s price movements.

In other terms, this is what happens if you take a short CFD position.

Now, three things can happen: the price of the asset falls, it rises, or it stays the same. 

If the price of the asset rises, then you incur a loss. You close the position by buying back the CFD.

However, if the price of the asset falls, you can profit by buying back the CFD at a lower price. The profit you make is the difference between the opening selling price and the closing buy price, less any costs or fees such as spread, commission or swaps. 

Let’s use a numerical example:

• You think the price of Company Y’s shares will fall.

• The price of Y's shares is currently $100.

• You open a short trade with a CFD broker, where you sell 10 CFDs.

• If the price falls to $80, you buy back the CFDs at this reduced price. This gives you a difference of $20 profit per share.

• Your total profit is $20 x 10 CFDs = $200 profit, excluding fees such as commission, spread and swaps. 

• If the price of Y’s shares rises to $120, your loss per share is $20. $20 x 10 CFDs = $200 loss. 

Markets you can short with CFDs

You can short sell with CFDs across multiple asset classes, including Forex, indices, commodities, crypto and shares. Let’s look at a few use cases of how traders use short selling across these different types of markets. 

Forex

Forex trading refers to buying and selling currencies through fluctuations in exchange rates. In short selling, traders may short a currency when they believe it will weaken against another currency. 

Unlike other asset classes, forex markets run 24 hours a day, five days a week. This means that short positions can react to events at any point during these hours. You may also have to pay a daily swap charge to account for any interest rate differential between the currencies in a pair.

Factors that impact the Forex market include interest rate cuts and political uncertainty. 

Indices

Indices measure the prices of groups of stocks (e.g., the FTSE 100 or the S&P 500). When people think the wider market could fall, they could open a short CFD position. The risk profile of shorting an index differs from shorting an individual stock, because you’re not tied to the fortunes of just one company. However, central bank decisions and other macroeconomic events can trigger swift moves in the market which can affect a short position. 

When deciding whether to short indices CFDs or share CFDs, both are high risk, remember that indices can fall due to economic declines or market corrections. 

Commodities

Commodities in trading include raw materials such as gold or silver and agricultural products like wheat and coffee. Traders short sell when they expect the price of these commodities to drop. Shorting commodities requires some unique considerations compared to shares or indices. The market for agricultural commodities like wheat is driven by the harvest cycle and even the weather, and many commodity CFDs are derived from underlying futures contracts which expire periodically, potentially shifting prices.

The price of commodities may also be impacted by geopolitical events and inflation. 

Shares (stocks)

Shares refer to the fractional ownership of a corporation. This is a popular type of short selling. Traders short sell stocks when they think a company's share price may fall. When learning how to short sell stocks CFDs, remember that shorting a stock focuses on just one company. Events like a takeover bid, or unexpected results in a quarterly report, can cause sudden moves against your position. Also, dividend adjustments may apply while a trader holds an open position.

Key mechanics of CFD short selling

If you need more details on how short selling with CFDs works, here are the main mechanics that make up CFD short selling:

• Swap charges or credits: A daily financing charge or credit for holding positions overnight, as there are financing adjustments applied to open trade positions after the end of the trading day. 

• Margin: This is the deposit you put in to open a short trade position. Traders only need to put in a small percentage of the total trade to open a position. For example, if there’s a 10% margin requirement on a $1000 position, the trader only has to deposit $100. However, there is a risk that they will need to add additional margin if the position moves against them and they receive a margin call.

• Corporate action adjustments: CFD short selling in company stocks may be adjusted to reflect changes in the underlying company, such as position size and price. This can include things such as mergers and acquisitions.

Risks of short selling with CFDs

There are, of course, risks to short selling with CFDs, and they differ from the risks of buying. When buying shares, losses are limited to the amount you invested, but when you short sell, there is no equivalent limit. This is because there is no cap on how high a market price can rise. A stock that a trader shorts at $50 could easily rise to $150, $200 or even higher.

Short CFD positions can also be impacted by sudden news events, price gaps, or market volatility. This risk is amplified overnight. Many traders use a stop-loss order, which automatically closes the position if the market reaches a certain price level, but it doesn’t eliminate risk. When the market closes, your position is left open, and you can’t act until it opens again. If it opens a lot higher than it closed, you may find your position filled at a much worse price than expected, even with a stop-loss in place.

If you’re trading as a retail client under ASIC regulations, you’re covered by negative balance protection. This means that your balance can’t go below zero, so your losses can’t exceed the value of your trading account. This mitigates, but does not remove, risk.

Start trading with Eightcap to explore short selling with CFDs further and access global CFD markets with multiple trading options.

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