Short Selling

Hello everyone ! first of all I would like to thank all of you for giving immense love to my previous blog and if you haven’t read it, i will share the link at the end of this blog, so please go read it to get insights about the Indo-China war. Today I will be writing about short selling as many people still don’t know what is it, how it works and how we can make profits out of it. First of all, I would like to define short selling. In layman terms, it is a trading strategy or we can say investment strategy in which we can buy and sell stocks on the same day or within few months and make profits out of it. let me help you to understand this with the help of an example. You are a car seller; a person reaches to your shop and ask for a car let say swift specifically of red color but unfortunately you don’t have that that car available in that color. So, what you will do is you will take the money from that person assuring him to deliver the car within a day and then you will go to another seller and take red color swift from him maybe at less or at same price to deliver it to the consumer. On the similar lines, short selling works. If you speculate that the price of a particular share let share A, will be going to decrease till the end of the day before the closing of the market. So, you will sell suppose 100 shares in the morning at Rs 100 (amount that you will get is 10000) even though you are not possessing the shares in reality. And when the price falls, you will buy those 100 shares the fallen price let say 90 (so cost becomes 9000). In this way your profit becomes 10000-9000 = 1000rs. Now many of you will have this question in mind that why stock market authorities will allow us to do so and is it a fraud? The answer is obviously no as if we see in a broader view, we are just buying and selling the shares. Now answering to the first question, why authorities will allow us to do so, basically the authorities check the transactions done by every investor on the next day. So, they will only see buying and selling of 100 shares and our overall balance that is 0. Now short selling can be divided in 2 categories, first is intra day and second one is short term selling. What I discussed in the above paragraph is the intra-day short selling. Now I will discuss about short term selling. It is just the extension of intraday selling to 2-3 months. This type of short selling works on SLB mechanism that is sharing, lending and borrowing mechanism. First a person let say A who feels that the price of a particular share will decrease within 2 months, so what he can do is he can borrow the share from a long-term investor let say B by providing him interest on it. Here the B will get benefitted as he will get additional interest on his share. After borrowing the share, A will sell the share at current price (assumed to be high as he feels that market price will go down) and after 2 months when price will actually fall, he can buy the share and return it to B and will get profit out of the change in price.

Although this appears to be very attractive deal but It comes with humongous risks as well. First of all, share market is very dynamic, and it can be possible that in spite of decrease in price, it will increase which will lead to loss as we don’t have the option not to buy the share at the end of the day. even if we do so, our broker will buy that share for us and adjust the price by selling the existing shares in our demat account and even if we don’t have any share in our demat account, then we will be declared as a defaulter. Also, we should have proper knowledge of the market and should be proficient in forecasting more precise market prices to reduce possibility of risk. Also particularly talking about short term selling, without doing proper analysis, if we go ahead and borrow shares in the hope that prices will decrease, we can face infinite losses as well as in normal trading, if we buy a share at 100 Rs, maximum loss that we can get on this share is of 100 Rs only as price cant be negative but in case of short term selling, there is no limit on increase in price of a share, it can be possible that we sell the share at 10 and after 2 months, company may perform extraordinarily, due to which share price in spite going down, increase up to 1000 or even more, so we cant really predict the losses and therefore, I will suggest only after proper analysis, go with it otherwise keep trading in normal shares.

So these are some of my thoughts and I hope they may help you all gain a deep understanding on the concept of Short Selling.

I look forward to hearing your valuable thoughts & comments on the same.