Short selling was a cornerstone instrument for increasing volumes on the local stock market in 2023. Such a financial leverage is expected to continue in 2024.
The Financial Regulatory Authority (FRA) has introduced short selling for boosting Egypt’s equity market as part of an overall reform programme.
Weekly average volumes rose from LE20 billion in 2022 to LE200 billion in 2023, according to data from the Egyptian Exchange.
The political stability has been the key driver for reform measures and economic growth, initiated by President Abdel Fattah El Sisi over the past nine years, paving the way for Egypt’s Vision 2030.
The New York-based Managed Funds Association (MFA) defines short selling as an important strategy used by investors, including fiduciaries managing others’ assets. “Market participants engage in short selling for different reasons, including to manage risk, hedge portfolios, and reflect a view that the current market price of a security is above its fair value,” the MFA says in its definition of short selling.
Short selling, along derivatives, is expected to pump more liquidity into the local equity market in the coming years.
Market equilibrium & risks
Short selling is meant to create market equilibrium. It is a key mechanism used by investors to buy and sell shares. Greg N. Gregoriou, a professor of finance at US-based University of New York, explained in his book on short selling that short sales can enhance market performance and improve a trader’s ability to allocate resources.
“Many investors believe that short sellers are responsible for market downturns, but academic theory does not suggest this. Instead, short sellers create liquidity in markets and are the best at spotting overpriced stocks as well as making markets more efficient through the aid of price discovery,” Gregoriou wrote.
However, there are risks that should be taken into consideration. On top of these risks come speculative attacks and volatility.
The finance professor tips governments to address these issues and hence improve their risk profiles instead of pursuing ineffective and distortionary prohibitions on short selling.
“Prohibitions on naked short selling are only another desperate attempt by politicians to do “too-little-too-late” improvisations. Governments should be held accountable for their mismanagement of macroeconomic risks.
“Governments should understand these risks as well as ensure that these are managed actively in advance in order to avoid speculative attacks, as failure to do so will give rise to so-called multiple equilibriums, thus when the probability of a risk-free bond to become a risky asset rises,” he stated.
Strategies
According to US-based investment bank JP Morgan, investment managers always have insights on which stocks they expect to rise in value over time and usually purchase these stocks.
The investment bank suggests three strategies: Market neutral strategies, long/short hedged strategies and 130/30 strategies.
According to the note, market neutral strategies use equal long and short positions (typically 100 per cent long and 100 per cent short). These portfolios seek to neutralize market risk and generate positive results regardless of market direction, with little or no exposure to overall market risk.
“Long/short hedged strategies use disproportionate long/short position ranges with a long bias (for example, 100 per cent long and 70-80 per cent short). These portfolios seek equity-like returns with less risk than the overall market,” it said.
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