Short Selling/Shorting

 Short selling involves borrowing a security whose price you think is going to fall from your brokerage and selling it on the open market. Your plan is to then buy the same stock back later, hopefully for a lower price than you initially sold it for, and pocket the difference after repaying the initial loan.

Traders may use short selling as speculation (Profit) and investors or portfolio managers may use it as a hedge against the downside risk of a long position in the same security.

Example

Example of Short Selling for a Profit

Imagine a trader who believes that ABC stock- currently trading at Rs.100-will decline in price in the next three months. They borrow 100 shares and sell them to another investor. The trader is now “short” 100 shares since they sold something that they did not own but had borrowed. A week later, the company whose shares were shorted reports dismal financial results for the quarter, and the stock falls to Rs. 90. The trader decides to close the short position and buys 100 shares for Rs.90 on the open market to replace the borrowed shares. The trader’s profit on the short sale, excluding commissions and interest on the margin account, is Rs.10, 000 (100 - 90 = 10 × 100 shares = 1,000).

Example of Short Selling for a Loss

Using the scenario above, let’s now suppose the trader did not close out the short position at Rs.90 but decided to leave it open to capitalize on a further price decline. However, a competitor swoops in to acquire the company with a takeover offer of Rs.115 per share, and the stock soars.

If the trader decides to close the short position at Rs.115, the loss on the short sale would be Rs.1, 500 (100 - 115 = negative 15 × 100 shares = 1,500 loss). Here, the trader had to buy back the shares at a significantly higher price to cover their position.