What is Short selling?
In Short Selling, you sell stocks that you do not own. Investors borrow these stocks from other brokers (like upstox , Zerodha ,etc). Generally, short selling is a best strategy to use when a stock’s price is expected to decrease. Short selling has a high risk ratio as it can cause big losses as well as gain profits. As a result, short selling is normally used by skilled investors when they expect the decline in price.
This is all about speculation. If the price of the stock increases, opposing the expectation of the investors, they suffer losses. Usually, short selling takes place in Bearish market which exhibits high scope of price drop. It is always a better practice to use strict stop losses while shorting a security.
- Fixes the irrational overpricing of stocks.
- Restricts the unexpected rise of poor quality stocks.
- Contributes liquidity.
- Prevents the manipulation of price by the promoters.
- Shorting can diminish stock prices. Therefore, Manipulators often use this illegally to depress stock prices.
- The purposeful decrease in prices can affect a company’s abilities in various fields.
Some of the important additional risks of short selling are given below.
- Borrowed Money :
- In short selling, investors use a margin account that allows them to borrow money from brokerages. For this, they use their investment as the collateral.
- However, the brokerages make it compulsory for the investors to keep a minimum of 25% in their accounts. If the investors fail to meet this, they will have to put in more cash.
- Moving against the trend :
- In general, the stock prices drift upward over the long run. But, short selling is about decline in prices.
- Consequently, short selling moves against the overall market trend. Therefore, the investors have to be extra careful.
- Inaccurate Timing :
- The price of a stock does not fall immediately. You will have to wait for the right moment. Until then, you are responsible to pay the interest.
Shorting is a risky method which depends on the assumption of investors. On that account, we are not recommending this to beginners. Furthermore, only investors with great knowledge about shorting should follow this strategy.