What Is Short Selling

What is Short Selling | Should you do short selling?

Friends, how would you be able to make money from a falling market or a falling stock? You read it right. It is possible to do this by short selling in the stock market. Usually we buy shares in the stock market and wait for the price of that share to increase to earn profit. But in Short Selling it is just the opposite.

So friends, you must have been curious to know about Short Sell?

But as a smart investor, you must have complete and correct information about Short Selling. Through this article, I will give you information about what is Short Selling, how does Short Selling work, what are the advantages and disadvantages of Short Selling and should you do Short Selling?

Table of Contents

If you understand Short Selling in easy language, then if an investor feels that the value of a particular stock is going to decrease, then he borrows that stock from his broker. After this, those shares are sold in the market. When the value of that stock falls, the investor buys back those shares and returns them to their broker.

If you are finding this confusing right now, then understand it with the help of an example.

Suppose you think that the share price of SBI Bank is going to go down. Now to take advantage of this opportunity, you sold 1000 shares of HDFC Bank for ₹ 100.

Here you did not actually have possession of the shares of HDFC Bank. You have shorted your position by borrowing these shares from your broker.

Your Total Sales Value is : 1000 × ₹100 = ₹1 Lakh

After some time the value of a share of HDFC Bank falls from ₹ 100 to ₹ 90. Now you buy your 1000 shares for ₹ 90.

Your total buying value is : 1000 × ₹90 = ₹90,000

You sold the shares for ₹1 lakh while you bought it for ₹90,000. In this, you got a total profit of ₹ 10,000.

What is Short Selling in Stock Market?

In normal trading, we buy shares first and then sell them. But in Short Sell, shares are sold first and then bought.

Thus, in short selling, investors sell the shares by borrowing from the broker to take advantage of the fall in the share price. Due to the sale of stock in spite of not having possession of the stock, it is called Shorting.

The trader buys back the stock as soon as the stock price comes down. In this way he squares off his position. That means the settlement becomes zero. The trader’s position becomes the same as it was before selling the shares.

The difference between Selling Price and Buying Price is your Profit/Loss.

SHORT SELLING FEATURES

1] Short sellers short the stock with the expectation that the share price will fall.

2] In short sell, the trader can have both profit and loss. The price is less.

3] Short selling can be done by any investor.

4] I hope you have understood the concept of Short Selling till now.

how many ways can a short sell be done?

Shorting in the market can be done in two ways –

1] Intraday Short Selling

2] F&O Market Short Selling

1] Intraday Short Selling

In intraday deals, both Buy and Sell deals are done in a single trading session. In Intraday Short Selling, a stock is sold earlier in a trading day and bought back before the end of the trading day.

In this way, in Intraday Short Sell, you have to complete both your deals in a single day. You cannot carry forward your position in intraday.

What if you forget to buy back the shorted shares?

Suppose you sold or shorted 100 shares of Coal India this morning at a price of ₹ 100 due to the estimation of falling price. But you forgot to square off your position by buying back these shares at the end of the trading day.

In such a situation your broker tries to buy back the shares for you at whatever time the intraday trades are square off which may be 03:10 or 03:20. If the sellers of Coal India shares are available in the market at the time of square off, then the broker will buy 100 shares for you at the market price and cut your position to zero.

Whatever the share price at the time of Auto Square Off, the shares will be bought for you at the same price. Whether the price is ₹ 110 or ₹ 90. If you have a loss from this deal, the broker will debit your trading account with the loss amount. That is, if you have suffered a loss of ₹ 1000, then you will have to pay it to your broker.

What will happen if the shorted stock gets upper circuit?

Suppose if you shorted 100 shares of Coal India for ₹ 100 in the morning session. But instead of decreasing the share price increased and 120 upper circuit was put on the stock.

The upper circuit ended the sellers in the Coal India market. In this situation you will not be able to buy back the shares of Coal India, due to which your position will not be squared off.

In this case you will be a defaulter. In this, the broker will buy the shares of Coal India through auction on your behalf and give it to the person to whom you sold the shares in your first transaction.

In return for this default, your stockbroker charges you a hefty fee. Therefore, to avoid such a situation, never forget to buy the shares sold in short selling on the same day.

Auction in Short Selling

Suppose you have borrowed 100 shares of BHEL from Ram with the help of your broker and sold it for ₹ 50. You promised Ram that I will return your shares to you by evening.But till evening you could not buy back the shares and could not return Ram either. But you have to return 100 shares.

Here you will be the defaulter. Now your broker is ready to return Ram’s shares.

This auction takes place in T+ 2 i.e. 2 days after the day you have done the shorting. All brokers are involved in this auction. In this auction, your broker buys 100 shares of BHEL and returns it to Ram.

If in the auction your broker bought BHEL stock for ₹60 and you sold it for ₹50. The difference between Selling and Buying price is ₹ 60 – ₹ 50 = ₹ 10 i.e. ₹ 1000 of total 100 shares will also have to be paid by you. Penalties are payable separately.

That is, if the broker buys these shares for ₹ 45 in the auction, then you will get 5 per share profit. But in most cases, this profit is deposited in the Investor Education Fund, not with you.

2. Future & Option Short Selling

The first type of short selling, you understood the intraday short sell which happens in the spot market or cash market. On the other hand, the other type of short selling is in the futures and options market ie F&O Market.

In Intraday Short Sell, you can keep your position short for a maximum of one day. But in short selling in the F&O market, you can keep your position short for about three months.

For example, if you think that the stock of SBI is going to fall in the coming one month, then you can sell SBI in the F&O market. When your target is achieved, you can close your position by buying back SBI shares within a month.

F&O A series of three months runs in the market. As today you have shorted the June series of SBI on 25th March and the expiry date of June series is 25th June, so you can hold your position till 25th June.

Future & Option Short Selling Important Points

1] F&O The facility of short selling is not available for all stocks in the market.

2]You need a lot of margin for short selling in this market.

3]In this, Short Selling is done according to the lot. You can only trade in multiples of those lots. Like SBI Bank the size of a lot is 3000 shares.

4]F&O Market is mainly used for hedging.

5]The expiry date is the last Thursday of every month

Short Selling Purpose

Friends, if seen, short selling is not a way of trading or investment. Short selling is considered a hedging method. Hedging means protecting your investment.

Confused ?

Let us understand this with the help of an example –

Suppose you have shares of PNB worth Rs 5 lakh. You have got the news or you are anticipating that the share price of PNB is going to decline in the coming one month.

As you have huge investments in PNB. Now you will use hedging to protect your investment.

You have shorted one month’s PNB futures in the current market. That is, today you sold the shares at a higher price. Let’s assume that today the share price of PNB is ₹ 100 and you have sold 5000 shares.

Total Sale Value – ₹ 100 × 5000 = 5 lakh

No 1

At the end of the month, the share price of PNB actually fell to ₹90. Now you have bought back the shares to clear your short position.

Total Purchase Value – ₹90 × 5000 = 4.5 lakhs

Now the value of your actual investment will be –

Old Investment : ₹ 90 × 5000 = 4.5 Lakh

Profit from Hedging : 5 Lakh (sale value) – 4.5 Lakh (purchase value) = ₹ 50,000

Here you have made hedging of your investment of ₹ 50,000 Damage covered.

No 1

At the end of the month, the share price of PNB actually fell to ₹90. Now you have bought back the shares to clear your short position.

Total Purchase Value – ₹90 × 5000 = 4.5 lakhs

Now the value of your actual investment will be –

Old Investment : ₹ 90 × 5000 = 4.5 Lakh

Profit from Hedging : 5 Lakh (sale value) – 4.5 Lakh (purchase value) = ₹ 50,000

Here you have made hedging of your investment of ₹ 50,000 Damage covered.

No 2

On the expiry of the month, instead of falling, the share price of PNB increased and came to ₹ 110. You bought back shares to clear your short position.

Total Purchase Value – ₹110 × 5000 = 5.5 Lakh

Now the value of your actual investment will be –

Old Investment : ₹110 × 5000 = 5.5 Lakh

Loss from Hedging : 5 Lakh (sale value) – 5.5 Lakh (purchase value) = – ₹50,000

In this case your guess turned out to be wrong but still you are in the same position through hedging as you were a month ago. (Current Investment Value – Loss on Hedging) = 5 lakh – 50,000 = 5 lakh

So you guys saw how by using hedging we can protect our investment from volatility.
Hedging is always done for a large investment amount. There is no point in hedging for small investments.

Risk in Short Selling

Short selling is much riskier than normal trading. In this, you trade by borrowing shares, which increases the amount of risk even more. There is no limit to the loss.

Benefits of Short Selling

1]Protects your investment from market volatility through short sell hedging.

2]By this, profit can also be made from falling market or falling stock.

3]It provides liquidity to the stock market.

4]The combination of long and short positions reduces the volatility of the stock.

5]It is believed that short selling improves the value of the stock.

6]You can also create your position with margin in short sale.

Disadvantages of Short Selling

1]There is no limit to the loss. If the price of the stock increases instead of decreasing, then the investor can suffer a huge loss.

2]In Intraday Short Selling, if the upper circuit has been placed on the stock, then it can be a nightmare for the trader if the upper circuit continues for the next few days.

3]There is a heavy penalty to be paid in case of default in short selling.

4]Excessive short selling can increase the volatility in a stock.

5]It is also used as a fraud technique in the stock market.

Conclusion – Should You Do Short Selling?

The simple answer is that if you want to be successful in Short Selling, then you need very good expertise and technical analysis for this. If you are a new investor then without any doubt you should stay away from short selling.

If you do short selling without thinking, then you can suffer a lot. Therefore, new investors and investors who do not have the right information about it, they should not do shorting.

Anyway, Short Selling is a hedging method and not any trading.

Friends, today you understood what is Short Selling in Share Market, Short Selling meaning and advantages and disadvantages of short selling.

If you liked this information, then definitely share it with your friends.

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What is Short Selling

What is Short Selling in Stock Market?

how many ways can a short sell be done?

1] Intraday Short Selling

2] F&O Market Short Selling

1] Intraday Short Selling

2. Future & Option Short Selling

Future & Option Short Selling Important Points

Short Selling Purpose

No 1

No 2

Risk in Short Selling

Benefits of Short Selling

Disadvantages of Short Selling

Conclusion – Should You Do Short Selling?

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