The sale of a security or share that the seller does not own is called Short Selling. In short selling, an investor sells borrowed shares in the market in the hope of buying them back at a cheaper price.
Short selling, also known as shorting a stock, is a trading technique in which a trader attempts to generate profits by predicting a stock’s price decline.
Short selling is essentially a speculative activity. The most simple way to define short-selling is speculating about the decline in a stock and then betting against it. This means that short selling is exactly the opposite to usual stock market investments, where an investor has bought a stock, hoping that its price will rise in future.
Short selling is profitable when a trader speculates correctly, and share prices do fall below the market price at which a trader sold short. In such case, a trader gets to keep the difference between the selling price and purchasing price as profit.
In short selling, an investor does not need to own a particular company’s shares to short them. Instead, they can borrow shares/assets of the company from any broker or dealer. The investor also need to have a margin account for shorting and need to pay interest on the value of borrowed shares while the position is open.
In Short Selling trader borrow the shares from the brokerage, sell them and then the proceeds are credited to his account. sooner or later – by buying back the exact number of shares and return it to your broker.
Short selling is profitable if trader succeed in buying the shares back at a lower price as trader get to keep the additional money credited to his account from the sale. However, investors must be ready to pay any interest or commissions charged by the broker.
But if trader prediction goes wrong and the stock price goes up, trader will have to pay an additional amount from his pocket. This means that the risk of a loss on a short sale is infinite/unlimited, as the price of shares can climb to infinity.
Advantage of Short selling: –
- The possibility of making huge profits.
- A little or no initial capital requirement i.e. you borrow the stocks and sell them.
Disadvantage of short selling: –
- Traders indulging in short selling are exposed to infinite risk
- Involves borrowing from a broker, and that implies bearing interest on the borrowed stocks and also maintaining the margin. If the margin is not maintained due to market fluctuation or otherwise, the trader might need to increase funding or liquidate his/her position.