If you have ever thought what exactly is short selling of shares, then you are not alone. It is one of those tricky strategies used by some of the investors to make a profit in the stock market by selling the shares at the higher price and then purchasing them at the lower price. The surprising part here is that they do not own the shares, they actually want to sell. Short selling is also known to short, selling short or going short.
What is the main objective of many people to invest in the stock market? To get decent returns and attain financial goals, isn’t it? Most of the stock market financial advisers quote a rule which says, “Buy Right, Sit Tight”. In simple terms, the quote implies that you must invest your hard earned money in buying the quality shares and hold them for a considerable period of time to get better returns when the market is performing well.
However, it also cannot be denied that the markets will also see a downward trend some days and this is where some of the individuals try to take an advantage of the situation and make a quick profit, by way of short selling.
What Exactly is Short Selling?
It is essentially a technique or procedure where an individual sells the shares today and wait for the prices to go down and purchase the same stocks at a much lower price than what was originally paid to get the shares and make profits. It is altogether a very risky technique. Let us understand this concept with a simple example:
Suppose you read somewhere that the prices of the metals industry have gone down in the international market and it will also adversely impact the shares of the metal manufacturing companies in the Indian markets as well. Taking advantage of the situation, you contact a broker who borrows the stocks from someone with a promise that the same will be returned very soon.
You waste no time in selling the shares at the current price prevailing in the market. If your anticipation turns right and metal stock prices take a plunge, then you buy back the shares at the lower price, which the broker returns to the person from whom the shares were being borrowed. Your profit will be the difference between the actual cost that you paid to sell the stocks and the price at which the shares have been purchased back. That’s not all as you will also be required to pay a fixed commission to the broker.
However, have you ever thought what if the share prices of the metal industry suddenly increase and your anticipation falls? Not only you will be required to replace the stocks sold, but the losses you have to suffer cannot be imagined at all. You have to be very precise regarding the timing of the stock market because it can go in any direction.
Is Going Short Beneficial or Disadvantageous?
Shorting of the shares is considered necessary as it helps in rectifying the price of the shares, which are overvalued. Investors, who back the short selling are of the view that its absence will provide a chance to the promoters to manipulate the share prices. According to them, short selling must be legalized in India with some amendments rather than completely prohibiting it.
There are also the people, who consider shorting a risk as it can destabilize the stock market. According to them, this practice can lead to the steep decline in the share prices that might not otherwise be reached. They are also of the view that a downward trend in the share price can affect an ability of a company to raise the funds, which may in effect its business operations. If short selling is carried out in the bearish market, then it can it lead to share price volatility, which may not be good for the market.
Short selling of the shares can look to be quite a tempting option in the first place because it allows the individuals to make quick profits. However, it must also not be forgotten that every rose has the thorns and this procedure also has its own disadvantage. It is quite risky and hence, you must formulate a considerable plan regarding when to enter and exit. If you are a beginner, then it is strongly recommended that you must maintain a safe distance from this strategy because it can result in unlimited losses.