Short Selling – The Basics What is short Selling ?
October 22nd, 2009
Advertisement
Short selling is selling the shares which you do not own. The term “short” here signifies that you do not hold the shares being sold. The first thought popping up in your mind would be – where do these shares come from which you are selling without possessing them in your portfolio of stocks. These come from your broker/brokerage firm that lends you the shares in lieu of your investment as collateral. You short sell these shares but subsequently you have to close the short by buying back the shares from market and then return it to your broker/brokerage firm. You are also charged some interest for the loan of shares you have taken. Below diagram describes the flow of shares involved in short selling
Short Selling
Looking at the flow of shares in above flowchart, one would ponder why to borrow shares for selling in market and then transfer them back to the lender? The logic behind shorting is very simple; earning profit margin. Let’s see how??
If you think a stock is overvalued and expect that the price would come down in future for sure; you would wish to sell the shares at current levels at higher price. So you borrow the shares and sell them at higher price. And when the stock actually falls as you had speculated; you buy it from market at lower price and return it to the lender and the difference between the selling price (higher) and buy price (lower) is what you earned in the deal. So at the end you must close the short by paying back the shares and this is called as “covering the short”. Concluding this, investors who anticipate fall in the stock price go short to take advantage of market fall. An investor can hold the short for as long as he wants but he is charged an interest as it is similar to a loan taken in the form of shares. Also if during the course of loan, the company declares dividend or rights issue, it must be paid to the lender who is the actual owner of shares because you are just a borrower.
Short selling is considered to destabilize markets directly or indirectly. In 2001, the stock prices crashed heavily owing to short selling by big operators after which SEBI banned it. After a gap of 6 years in December 2007 SEBI came up with updated norms of short selling to cover the loopholes and ultimately institutional investor were also permitted to short sell.
Concluding this, short selling no doubt gives you an opportunity to earn profit by taking advantage of downturn of markets, it might bring in huge loss to your investment if stock price moves up. Because in real sense, shorting is a bet against the current market trend. When stock is at current higher levels, you are expecting it to fall down and entering the arena. Speculation is what makes shorting a riskier job. So beware of the dark side of shorting before you actually go for it!
All the Best
Renuka Kinger
Advertisement
Categories: Investing Trends, Trading Basics, Your Money
Great piece of information for all !
Great info….Thanx a lot.
ARTICLE IS VERY NICE & WRITTEN IN A SIMPLE & LUCID MANNER WHICH IS EASILY UNDERSTANDABLE .
Too good… for all the types of trading there is a darkside … thanks for mentioning it !!!!
hiiiiiiiii i m doing hotel management and pls tell me the full concept of sharekhan
Good explanations and graphics. But I am new to this whole game, so I’m a bit confused. How does ‘short selling’ actually works for the investor? If he is ‘borrowing from the broker’, doesn’t the broker lend him the stocks at current (high) market price? So if he sells it at a lower price, won’t he be actually losing money? What exactly is meant by ‘lending’?
thks nice and understandable
Short selling is of two kinds- intraday and delivery/open.
In Intraday sort selling you have to close you position by the end of the trading day by buying the same amount of shares that you have sold short.
In Delivery/Open short selling you may carry your position for several days (up to 12 months) as you wish but for that you have to borrow the same amount of shares and deliver them to the buyer on pay in/pay out day.
The articles are very informative,where can i get all these articles in the form of a book or a soft copy of it,can u please inform,i will be very thankful to ur team
very informative, my concept of short selling got cleared by this,
thank you
i am holding shares in demat form in with krvy stk .
How can i transfer these shares to some other broker some other account.without selling .
i am a doctor . i want to get ful knowledge of share market so is it any books are availabal in market please reply me
your article is very good and in layman language and any one can understand the basic of short selling. i am appreciate to you and you article
[...] of a trader should to buy a stock at support and sell at resistance. For traders involved in short selling short at resistance and then cover the short at [...]