What is short selling?

Short selling is an investing strategy used by traders to take advantage of bearish market trends. Short selling means to sell securities without having ownership.

What is shorting?

To put it out simply, Shorting is a trader’s practice of benefiting from falling market. Instead of taking a long trade and waiting for rising market, by shorting, a trader can make potential profit as market witnesses a dip. The Shorting strategy is implemented in a bearish market. However, in case of an incorrect analysis and bullish market, traders may suffer losses.

Factsheet of Short Selling

Here is a factsheet on short selling

  1. In short-selling, the seller does not have ownership of the securities. Instead, he sells the borrowed shares.
  2. Institutional as well as retail investors may enter into short selling.
  3. Traders must return the borrowed shares to the seller at settlement.
  4. Short selling is typically practised in bearish markets.
  5. Short Selling is only allowed in intraday trading.

What is short selling in the stock market?

Contrary to investors who intend to hold stocks long-term, hoping for prices to rise, short sellers bet on benefitting from falling stock prices. Stock prices may not immediately dip as you enter into short selling. If the security prices decline instantly, the trader who has entered into a short-selling transaction might buy the securities in the open market and book a profit. Let’s decode short selling with the following example.

A trader speculates that the current market price (CMP) of a security is overvalued at Rs. 100/share. He expects the price to take a hit during the day as the company announces the quarterly results. He short sells ten stocks and at the current price, i.e. Rs. 100. The company released its earnings, and as expected, prices fell to Rs. 70/share. The trader purchases these stocks at their current prices and returns them, making a profit of Rs. 30/share. However, if the prices rose, the trader would still be obligated to return the borrowed stocks. In such cases, he would have no option but to buy expensive stocks that he had already sold for a much lower price, thereby incurring a loss.

Benefits of short selling

The advantages of short selling are described below

  1. Traders can achieve substantial gains if a bearish trend sets in.
  2. Short selling can help traders hedge against the downside risk of their securities.

Dreawbacks of short selling

The disadvantages of a short selling strategy are outlined below.

  1. Short selling exposes traders to substantial risk in case of bullish runs.
  2. Short selling is only available for intraday trading.
  3. Short selling is time sensitive. It requires traders to identify trends at a suitable time and enter the trade accordingly.

Naked short selling

In naked short selling, traders tend to sell shares without borrowing/buying them in the first place. These are riskier than regular short-selling contracts since, at the time of fulfilment of the agreement, the securities might not be available, and the contract may fail. Naked short selling is deemed illegal in many countries since it defies supply and demand rules and may destabilise the markets.

Can I Short Sell In Delivery Trading

Short selling is only available under intraday trading. In delivery trading, short selling is not available. In delivery trading, share is bought first, and the delivery of share takes place in T+2 days, where T is the day of transaction. Only the shares already available in demat account can be sold under delivery trading. In Option trading, short selling can be placed for both Call and Put contracts. Similarly, in Futures contract, short selling is permissible.

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