Short selling is the phenomenon in which the investor sells the shares that they don’t own at the time of a trade. In short selling, a trader will borrow the shares from the owner with the broker’s help and sell them at market price when online trading with the aim that its price will fall. When the price falls, the short seller purchases the shares and earns a profit.
Seasoned traders and investors carry out these practices in the stock market, and they are based on the speculation that the share prices will drop before they are provided to the owner. Short-selling has a high risk to reward ratio since traders can get a good profit and incur some losses. However, before getting into short selling, it is important for individuals to learn the rules involved. As per SEBI’s rules, only retail investors are allowed to conduct short selling. In March 2020, SEBI again changed the rules for making short-selling difficult. They said that short-positions in index derivatives of an entity, including FPIs, traders, mutual funds and clients must not be higher than their stock holding.
Some key facts about short selling are:
1. The seller is not the owner of the shares they are selling. They are borrowed from another owner.
2. Short selling is dependent on speculation.
3. Both retail and institutional investors get to short sell.
4. The seller will bet on a price drop when short selling. If the prices rise, the seller suffers some losses.
5. Traders would have to honour their obligation and provide the shares to the owner when settling.
Market regulators worldwide have approved the practice of short selling since it helps correct the irrational overpricing of a stock, offers the liquidity, prevents the sudden rise of faulty stocks, and makes sure that promoters do not manipulate the prices.
When you correctly predict the price movement for short selling, you will get:
1. Low capital investment
2. Earn huge profits
3. Possibility of hedging against bear markets
4. A new source of revenue and liquidity