Short sellers triumph as Wirecard collapses – but who’s next?

CFD Trading
Equities

Those shorting Wirecard will have been rubbing their hands with glee after the events of the past few days.

The company, once one of Germany’s tech darlings, last week filed for insolvency after admitting that almost €2 billion in cash missing from its balance sheet likely didn’t exist.

In the space of 11 days the stock price collapsed from just over €100 to as low as €1.15. In the week ending June 26th, Wirecard short sellers made $1.2 billion, with hedge funds accounting for the bulk of that.

Wirecard has been a heavily-shorted stock for a long time, thanks in part to negative coverage by the Financial Times, which has long warned that the company’s finances don’t add up. The stock was so heavily shorted that in February the German financial regulator took the unprecedented step of banning new short positions on Wirecard for an entire month.

Wirecard stock is a fraction of its former value after the 95% drop witnessed over the past 12 days. While hedge funds are still piling in to short the stock, many shorts have already locked in their profits. So what might be the next big target for short sellers?

GSX: Inflated revenues and fake users?

GSX Techedu is a tech company and online education provider focusing on after-school tutoring for primary and secondary school children, as well as courses in foreign language, and professional development amongst others.

The company has been the focus of short sellers for some time now. As of mid-May over a fifth of its publicly traded stock was sold short – 27.3 million shares, worth $815 million at the time. This makes GSX the fourth largest Hong Kong or Chinese equity traded short on US exchanges after Alibaba, Pinduoduo and JD.com.

The company faces claims from Citron Research and Muddy Waters that it has inflated its revenue figures. Citron, which has called GSX “the most blatant Chinese stock fraud since 2011”, has questioned the 431% year-on-year revenue surge reported by GSX in 2019. Additionally, Muddy Waters believes that around three quarters of the company’s reported students are actually bots rather than paid users.

GSX listed on the New York Stock Exchange on June 6th 2019 with an initial offer price of $10.50. The stock is now trading at around $58, and has surged 146% this year.

You can trade this hotly-watched stock on the Marketsx platform.

Tesla shorts down but not out

Tesla founder Elon Musk has been battling against short sellers for a long time. The huge rally seen in the stock price in recent months, while dealing a painful financial blow to short sellers, seems to have only hardened their resolve. Back at the end of January, a stronger than expected earnings report from Tesla saw shorts lose $1.5 billion in a single day. Then, at the beginning of March as the pandemic panic set in, Tesla’s tumble netted shorts $2.8 billion.

Tesla is the most shorted US stock, with the value of its float out on loan rising around $3 billion in the last two months to over $16 billion. That’s around 11% of its publicly available stock. The stock recently rose to trade above $1,000 per share for the first time, helped by resilient demand for its vehicles in China and progress towards a one million mile battery, which could revolutionise the electric vehicle market.

However, shorts believe there is still a large disconnect between where the stock is now and the fundamentals of the company – it went public ten years ago and, while the stock is up over 4,000% since then, Telsa has never delivered a full year of profitability. Shorts are betting that a lot of the recent gains seen in Tesla stock is because of momentum traders, and that the bubble will eventually burst.

Will Hammerson follow Intu into administration?

In the UK, shopping centre owner Hammerson attracted a lot of attention from short sellers during the height of the pandemic panic in March. It’s the most shorted UK stock, with 13% of its publicly traded shares out on loan. A total of nine hedge funds are betting against the stock, as the impact of the lockdown to battle Covid 19 and the prospect of a sluggish reopening hampered by social distancing measures, threatens the outlook for the company.

Rival Intu, owner of some of the UK’s largest shopping centres, entered administration this month. The company was already heavily laden with debt, and the coronavirus pandemic proved to be the final straw.

The fate of Intu shows just why short sellers are interested in Hammerson: as of the end of last week the collapse in its stock price left Intu valued at just £16 million, down from £13 billion in 2006.

While Hammerson raced higher from its mid-May low as its tenants prepared to reopen their stores, the stock has since lost nearly half its value again.

What is short selling a stock?

Short selling, or shorting, is a strategy used by traders in an attempt to profit from falls in the price of a stock. While you can short other assets types, such as FX, commodities, or indices, stocks are the most commonly shorted instrument.

How short selling works

Traditionally, a trader interested in shorting a stock in a company needs to borrow them from someone who already holds them, like a broker. They then sell these shares at the going market price.

If their prediction is correct, and the shares in question do appreciate in value, they are able to repurchase the same quantity of shares that they borrowed for a lower price than they received when they first sold them. They can return the shares to the broker and keep the difference between the original sale price and the repurchase price – minus fees – as profit.

For example, imagine a trader interested in short selling Goldman Sachs borrowed 100 shares on June 5th, 2020, and sold them for $22,200 ($222.00 per share). They then waited until June 26th and bought 100 shares in Goldman Sachs for $19,000 ($190.00 per share). Without fees, they would have made a profit of $3,200.

A candlestick price chart illustrating short selling Goldman Sachs

Thanks to contracts for difference (CFDs), you don’t actually need to borrow or sell a stock in order to short it. You can simply short the CFDs, which are derivatives that track the price of the underlying stock, instead.

Why trade stocks short?

Shorting a stock gives you even more flexibility in how you trade the markets. There are many opportunities that you can take advantage of, as not every business has promising fundamentals or operates in a strong sector.

Wirecard is a perfect example. Although it was considered one of Germany’s leading tech companies, many, including journalists at the Financial Times, raised alarm bells. Wirecard was accused of misreporting its financials, giving the market a false impression of its business.

In June 2020 short sellers were vindicated, when, after having delayed reporting its results as many times as the regulators would permit, Wirecard was forced to admit that nearly €2 billion in cash that was missing from its balance sheet probably did not exist.

The share price collapsed. In the two days following the company’s bid for insolvency, the share price fell almost 100%, and short sellers made a total of $1.2 billion in the week ending June 26th.

Short selling isn’t always a sign traders believe that a business is poorly run or hiding potentially criminal activities. Sometimes they just believe that the market has made an error in how it is valuing the company, and that eventually the price will correct lower to reflect its fair valuation. Or they could be expecting that a wider market downturn will impact the stock in question more than others.

What is a short squeeze?

Short positions lose money when the asset in question rises in price. If something happens to drive an stock significantly higher, short traders may be forced to close their positions to prevent further losses. In order to close a short position, a trader needs to buy the stock that they are shorting. This increases the demand for the stock and pushes the price higher still. More and more short sellers are forced to close their positions because of rising prices, which in turn pushes prices higher and forces out more short sellers.

This is known as a short squeeze.

Using risk management when short selling

Just like with a long position, you can use risk management to lock in profits or limit losses when trading short.

Risk management on a short position works the opposite way around to a long position. So where a stop loss order on a long position would be placed below the entry level of the trade, on a short position your stop loss would be placed above it.

Similarly, your take profit level would be at a lower price than your entry price.

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