Short selling is a context of selling securities that investor does not own. But an investor sells them as the price might decline. An investor will make a profit by buying back them at a lower price. In short, it is a practice of selling the instrument that is currently not owned and usually borrowed. If the price goes up, short selling ends up in a loss. It is also known as shorting.
This post explains the basic concept and its features. SEBI allows retailers, domestic MFs, and institutional investors to short sell. But banks and insurance companies are not.
Key Features of Short Selling in Indian Market
Find the basic features of short selling in India.
- All types of investors can participate in short selling
- An investor earns a fee when lends his shares to the short sellers.
- It is an essential feature for providing liquidity to the market.
- They also help in correcting pricing of overvalued stocks.
- It allows promoters to manipulate prices.
- Investors are required to disclose their ability to borrow before transaction or order.
Benefits of Short Selling
Short selling has many benefits for the investors and the market.
- Short selling allows making money when the prices are down. Investors can buy back at lower prices after a decline.
- Investors gain money from the price drop.
- Less money is involved compared to the stocks.
- Going short is an easy and simple process.
- Contrast to the cash market, you can sell without owning.
- You can sell single stock futures at a higher price. The price can be higher than the actual stock price.
Why You Should Short Sell
There are basically two reasons for going short. Check out and you will understand why any investor would involve in this concept.
- Trading and Profiting – The most common reason to short sell is to earn a profit. Investors earn a profit in the bearish market.
- Hedging – There are very few active investors in this type of trade. Hedging means an investor is protecting other instruments with long positions. Investors offset the risk of long positions with short selling.
Types of Short Selling
There are mainly two types of short sales in the Indian market.
- Covered short sales
- Naked short sales
Covered short sales allow the seller to arrange delivery of the shares he has sold through borrow. In naked short sales, the seller does not provide the delivery. Naked short selling is not much preferred. The reason is it does not give documentary proof of borrowing before the transaction.
Types of Short Sellers
Very few participate regularly in going short. But mainly there is a certain type of investors who prefer to be short sellers.
- Hedgers – Some investors rely on short sell gains to compensate the risks of other instruments.
- Speculators – Other investors also short sell just for speculation.
- Day Traders – Day traders also short sell to use their ability of closely tracking the trading positions.
Major short selling is done by the hedgers and speculators.
Risks of Short Selling
Every instrument in the market has its own benefits and risks. Here we have explained the risks.
- If the speculations go wrong, you can lose money.
- If a large number of short sellers are there, it can increase the price instead of decrease.
- In short selling, you selling when the market is up. You are going against the trend and it is risky.
- There is no way to predict when the stock will fall or rise.
Long term investor can wait for the right time to act when prices go up. But the short seller has to take action quickly.
If you are looking to short sell for an easy gain, better stop now. Actually, short selling is more like speculating than investing. There is no huge gain thing with short selling. There is equal potential for loss as well gain. But you can act wisely while taking risk.