What Is Short Selling?
Usually, we know that in the Stock market investors
buy shares when the stock prices are low and sell those shares when the stock prices are high, this way most investors make a profit.
But if I tell you there is another way also!.
Investors generate very high returns in a falling market also, with this trading strategy investors able to make money in decline share market.
Short selling is an advanced investment & trading strategy, where investors Generate profits in the declined Share market.
Not only in declined share market but,
sometimes “short selling” is also used against any particular stock whose share price will decline continuously
over the period of time.
Understanding Short Selling
In Short selling, an investor sells shares that he does not own at the time of a trade.
By simple means, suppose any particular trader speculates that particular stock price will decline very soon, then he will sell that particular stock which, he does not own yet, but! he needs that particular stock for completing overall trade, so he will buy that particular stock only when its prices will go low,
this way he sells that stock at a high price and buy it at low price.
To keep it more simple, let’s take an example.
- Suppose person “A” wants to sell his house, so he listed his property to a local real estate agent at a price of 50 lakh.
- Now person “B” wants to buy a house so he goes to the same local real estate agent and selects A’s Property.
- The real estate agent then told “B” the price of the property is 80 lakhs.”B” agrees with the deal and pays the 80 lakh.
- Now A sells his property at 50 lakh and B buys that property at 80 lakh and,
the difference 30 lakh is going to real estate agents pocket, in this case, real estate agent work as a “Short seller”.
Although this example is not up to the mark but, it will give a basic idea about short selling.
How Short selling works?
- First short-seller speculates that the share price of any particular stock will decline soon.
- Then Short-seller borrows that particular shares from his broker, for a limited time.
- Then he sells those borrowed shares to other retail investors at their current market price (let’s say $500).
- If short-sellers speculations are correct then, share prices of that particular stock start declining.
- When prices reach to its low (say $300) then, short-seller start buying that stock.
- Then after buying, short-sellers return those borrowed shares to the broker before the limit days.
- Now what happens is short-seller sell those borrowed shares at $500 and again buy those shares at $300 and, after that return those borrowed shares to the broker, so the $200 profit totally goes to short-sellers pocket.
This is how short selling usually works.
Points to Remember
- In short selling, Retail investors do not own the shares he is selling,
they will borrow the share from another retail investor.
- Short selling is based on speculation.
- after selling, investors need to buy that stock before the day’s limit.
- in short selling investors bets on the shares price drop, when instead of drop,
stock prices surges then investors have to suffer very high loss.
- whatever happens short sellers need to return the shares to the broker before settlement day.
- Short selling usually happens in bearish markets when the scope of price drop is high
Drawbacks of short selling
- Short selling is very risky and, only professional and expert investors and traders can perform short-selling effectively.
- Since short-sellers bet on the declining market, which is the opposite of the natural flow of any economically developing nation,
therefore sort selling has become more riskier.
- Short selling technique mostly used illegally by market manipulation.
- In the stock market it is comparatively very easy to surge the stock prices,
by “demand and supply method”, “GameStop Controversy” was the best example of short selling fails.
- Timing is very very important factor in short selling,
investors need to sell & buy any particular stock at right time, otherwise, they may suffer a very high loss.
- Bear market is the only ideal condition for Short selling, otherwise, it is very risky.
- Debt-free companies in India.
- What is Cryptocurrency?
- Difference between Fundamental analysis and Technical analysis
- Types OF Stocks
- SIP Vs LUMP-SUM ; Which is better ?
- Mutual Funds; Types of Equity Mutual Funds
- Stock Trading vs Investing: Difference between Trading & Investing
- GOLD; Gold investment plans in India