In the stock market, investors frequently seek money-making opportunities not just when prices are rising, but when they are falling. There is one such method called short selling or a short sale. This can be a high-reward strategy, but it also involves high risk. If you’re green when it comes to investing, then that’s important for you to know what short sales are, how they work and if they live with how you invest.
What is a Short Sale?
A short sale is when an investor borrows shares of stock from a broker and sells them into the market with the expectation that prices will drop. It is a bet that the investments in a market will not increase, since the investor eventually buys back equal number of shares at lower prices and returns to them to the broker. The profit is the difference between those buying and selling prices.
For instance, if you sell a stock at ₹500 through short trading and later buy it back for ₹400 then you book a profit of ₹100 per share.
How Do Short Sales Work?
1. Borrowing stock: The investor borrows shares from a broker.
2. Current price sale: The borrowed shares are sold in the open market.
3. Price waiting: The shareholder is banking on the share price dropping.
4. Reputation: The investor buys back the shares at the lower price.
5. Returning the shares: The broker receives back the shares and delivers the profit (or loss).
Rewards of Short Selling
Short sales can provide opportunities that regular purchase (going long) does not offer.
- Profiting in falling markets: When the market is down, most investors lose money; short sellers can do well.
- Hedging: Short sales can be a way for investors to protect themselves from losses in their portfolio. As an example, if you are long one stock, you might short another related company to offset the risk.
- Short timeline: Rather than waiting several years for an investment to appreciate, investors can make profits more quickly with short sales by betting on more immediate price movement.
Risks of Short Selling
The potential rewards are attractive enough, but the risks are off the charts.
- Unlimited losses: In regular buying, the most you can potentially lose is however much money you used to buy things. But there is no restriction in short sales. And if the price of the share rises instead of falling, you can suffer large losses.
- Margin requirements: Brokers require investors to maintain additional money or securities in their account. If the stock goes up, you will have to put in more money to stay in it.
- Short squeeze: Occasionally, large numbers of investors bet against a stock. If the price unexpectedly surges, they scramble to buy back shares in order to cover their losses. This demand in turn drives the price still higher, setting off a chain reaction of losses.
- Borrowing costs: Because you must borrow shares from a broker, interest or fees may have to be paid.
- Market risk: Any piece of news, announcement, and unexpected event could move the stock price rapidly.
Is It Right for Your Now?
Short sales aren’t for all investors. They require strong market knowledge, rapid decision-making and the willingness to take risks. Those new to scam baiting should avoid this method. Even professional investors only short sell sparingly, never with more than a small percent of their assets and always with careful stop-loss planning.
If you are a long-term investor who is in search of consistent returns, short selling might not be for you. But if you are an active trader who pays close attention to the markets, short sales can be a helpful added tool for profiting in falling markets.
FAQs:
Q1. Can anybody do short selling in India?
Yes, but it is typically intra-day trading. As per Sebi regulations, retail investors are permitted to take intraday short positions. Institutional investors have more flexibility.
Q2. What if the price of the stock rises, not falls?
If the price goes up, you’ll need to repurchase at higher prices. This results in a loss, and the loss may be quite heavy.
Q3. Is there a special account for short selling?
No, but you’ll require a trading account with a broker which is authorized to offer margin trading. You may also be required to have adequate collateral.
Q4. Is short selling illegal?
No, short selling is legal in India (and in most countries) but it’s highly regulated.
Q5. Should beginners try short selling?
For Novice Investors Do not short sell in the beginning as risks are very high. It would be better to start with the basics and experiment with practice until making expensive trades.
