Short Selling

Short Selling is a trading technique where a trader seeks to capitalize on an anticipated fall in the price of the security. Basically, short selling means selling a stock which the seller does not own but are promised to be delivered at a future point of time. The sellers need to borrow the stock from the broker. The broker might lend the shares from their own stock or from the stock of their account holders.

For example, you want to short sell 200 shares of ABC Ltd. worth $70 each. Your broker will lend these shares to you. You will sell these shares and proceeds worth $14000 (200 × $70) will be credited to your account. Say, after a month the price of the shares drops to $55 each. Now you need to buy back these shares from the market and return these to the person you initially borrowed from. You will buy them for $11000 and you get to keep the difference $3000 ($14000-$11000). However, if the price of the shares touch $75 each, you will lose about $1000 from the whole transaction. The broker will keep a cut of your profits or charge commission for lending and carrying out the transaction.

There are various risks associated with short selling. Since, the price of the shares can go up to any value but won’t go down below zero, your losses can be infinite. Also, you are acting against the nature of the market to go up by expecting it to bottom down. Furthermore, short selling can lead to a position called as ‘short squeeze’. Various collateral and margin requirements should also be adhered to while dealing in borrowed stocks.

With various risks and legal requirements involved it’s still lucrative to short sell as you can easily maximize your gains either by speculating and generating profits or by hedging and protecting your long term positions.

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