trade talk

Understanding Short Selling in the Stock Market
Stock Market Basics

Hi friends. We hope you are enjoying your overview of the Indian Stock Market and the basic concepts of the Market. I was to start with the intermediate topics thinking you are well versed with the basic concepts. But then I realised, we have to cover a couple of topics before we move forward.

So without wasting more of your time, let’s take one of them today. We will discuss what is Short Selling, its importance in current market scenario and the risks involved in short selling.

So what is short selling? Short-selling, in the context of the stock market, is a practice of selling shares by a trader when he does not own them at the time of selling. A trader short sells them hoping that the prices of the shares will decline, and he will profit by buying back those shares at a lower price.

So now we know that we can even make profits by selling shares first and buying them later. The concept may sounds easy, but there are substantial risks that we need to watch out for. In short selling, the investor’s risks are high so it is important that we understand the banes and merits of the transaction before getting into it.

Benefits of short selling:

  1. Short-selling is considered an essential feature of the securities market for providing liquidity to the stocks and the markets.
  2. Short selling helps in price corrections in over-valued stocks. Absence of short selling can distort efficient price discovery, gives promoters the freedom to manipulate prices and favours manipulators than rational investors.
  3. Short Selling gives investors an extra hand to combat extreme price volatility in highly uncertain and volatile market situations.

You might have loved the benefit of short selling, but there can be a lot of risks attached with short selling. Take a look at the reasons why short selling can be risky and decide whether to go for it or not.

  1. Historically, equity markets have gone up instead of going down: Short selling as a strategy takes advantage of downward movement in prices. Historically though, equity markets have moved upwards. Thus, if we agree that the direction of markets is generally bound upwards, then holding on to a short position for a long time is betting against the historical trend of a market and can be very risky.
  2. Possibility of unlimited loss and margin costs: Since markets do not go down forever, there is a limit to the downward trend, short selling gives limited profit with chances of unlimited loss. This happens because if your call on the short sell doesn’t play out then the loss on the transaction depends on the rise in stock price before you are able to close the short position. And theoretically, the stock price can rise to any level, whereas the gain is limited since the stock price cannot go below zero.
  3. Trading discipline: A trader should always exit the market once the target is achieved or the stop loss is triggered. But as this discipline in market is against our natural instincts of fear and greed it is often not achieved and most of the times this results in losses for traders.

Short selling can provide good gains to us, risks attached with it can sometimes overweighs the returns. Thus we advise all our clients to take utmost precaution while short selling a stock or derivative. Remember to always use Stop losses and book regular profits and always stay focused.

At Moneypalm, our constant endeavour is to provide you able guidance which helps you to make a guided decision based on facts, research and reasoning. We at Moneypalm always want you to make the right choice, not the more lucrative one, as our motto is “Together We Grow”. If you grow, we grow along with you. We are a family after all.

Happy trading friends.

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Pratyush DixitConsultant - Digital Marketing and Content

Pratyush is a Post Graduate in Marketing Management and has a leadership experience of nearly a decade in diversified industry including Stock Broking. Having headed companies for over half a decade, Pratyush brings with him, rich Marketing and....

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