(also known as “Shorting” in stock world)
Short selling is a way to bet that the price of a stock or asset will go down.
To make money in short selling an investor borrows shares of a stock, sells it at a current price with a hope of buying the same share back at a lower price at some future date. An investor can use lowered stock prices to return the shares borrowed and keep the difference. Nonetheless, an investor can incur a loss as well if the prices increase and this loss would be relative to the initial investment amount.
How Short Selling Works:
Let’s step through the mechanics of the process – the way it works:
Borrow the Shares:
To begin with, you “open a position” on a stock by borrowing shares from your broker or from another stock holder.
Sell the Shares:
You will now sell these shares you just borrowed to the current market at the going price.
Wait for the Price to Drop:
You as the investor expect the price of the stock traded to appreciate as time passes on.
Buy Back at a Lower Price:
Otherwise, when the stock price appreciates you buy at that price and later sell that appreciating stock at a lower price when you have to hand it out to the lender.
Profit or Loss:
If the price falls, as an investor, you earn from the trade because you are able to buy at a lower price with hopes of selling at a higher price.
On the other hand, if prices escalate you end up losing a bit of money due to the price of stocks appreciating.
Why Do Investors Short Sell?
It becomes evident that for one reason or another investors expect a short term decline in stock prices then they almost always will short sell the stock. Hence this statement can give a solution to our previous question.
Risks of Short Selling
- Infinite Losses: If a stock price rises while short selling position was taken, infinite losses are possible.
- Market Risk: Positive news or a earnings report announcement could also cause the price to rise.
Example of Short Selling
For example, you are bearish on a stock which is trading at a price of 1 lakh rupees and buy at a strike price of 800 rupees. You are able to sell these sold shares at a low market price of 820 rupees and later buy them at 80 thousand rupees. In that case, you will be able to afford the low market price of 80 thousand rupees.
