Have you ever came across the term SHORTING or SHORT SELLING? If you are a day trader or F&O trader, Probably i must say that you are quite familiar with this activity. But if you are a newbie to the capital markets, you must understand this concept to make good returns even if your stock doesn’t perform well. Through this blog post i would like to explain the Concept and basic functionality behind the term Short Selling. Are you Ready? Here we go.
What is Short Selling? How can a trader benefit from that?
Now let me just start off with the common understanding of stock movements and making returns out of such stock fluctuations.
“The universal understanding about the stock market and trading activity is that “You make good returns only when your share performs good”. Isn’t it? Yes. It is. Because this is the kind of way that every one thinks of. But would you believe me, if i would say that there is a way that “You can still make good returns even though if your share doesn’t performs well?”
Hmmm.. Yes, you got it. That is where the concept of “Short selling” comes into the picture. All right, now let me explain you what is this short selling about? and when you can implement this?
Short selling the sale of scrip that is not owned by the seller or the seller has borrowed. It runs on a motivation that the price of particular stock will decline and then enabling it to buy back at lower price to make a profit.
Lets say Mr. John is the trader in Stock markets and he predicted that the stock price of “Company X” will go down in future days. In order to make the profit from his prediction, John decided to short the Company X’s stock . But how can he do this? John approached his stock broker and tells him that he wants to short 100 shares of Company X. To execute this trade, the broker needs to find 100 shares of Company X to lend to John.
After looking into the various sources like stock inventory, clients portfolio and other brokers, he could able to find 100 shares of Company X and sold to Mr. John in stock market. At that point of time the price of such company’s share was trading at $100. Now John was waiting for the time to decline in stock price. As per his prediction, the financial performance of the Company X doesn’t seems well and due to this issue the price of such stock has became $70 .
Hence John made a Short against the Company X, he wants to cover his position and called his broker to cover his position in Company X. Now broker uses the money from the John’s brokerage account and buys 100 shares at the current price of $70. Then he returns the stock to his client’s portfolio. Here Mr. John sold the Company X stock at $100 and bought it back at $70. In net he made of profit of $30 ($100 – $70) on 100 shares. Hence the total profit is 100* $30 = $3000.
Yeah!! John is extremely happy with this trade and out of the profit that he made John has to pay a little amount of fee to his broker for the service that he delivered. That is the story of John and his Shorting technique.
It seems pretty well, right? Of course, but you know what? Trading the stocks by shorting is extremely risky in nature and there might be a chances of loosing money in a huge amount. Short selling is generally meant for advanced and day traders.
That’s it. Ta-daa!! You are done.
If you are looking for other information on accounting, taxation, business incorporation and its legal formalities, do read more articles on my blog.
Thanks for reading this article. Please share your thoughts in the comment section below.