What Is Short Selling?

The capital markets regulator, the Securities and Exchange Board of India (Sebi), recently issued a new circular which said that while placing orders, institutional investors will have to inform in advance whether the transaction is short selling or not. The order also said that retail investors would be allowed to make similar disclosures till the end of trading hours on the day of the transaction.

Sebi has allowed short selling by all categories of investors, including retail and institutional, but has also imposed certain conditions to prevent market manipulation. Let’s understand more about it.

What Is Short Selling?

• It is also known as ‘shotting’. Under this strategy, traders first sell the shares to buyers at a higher price and then buy them back at a lower price at a later date or time.
• The price difference between these is the trader’s profit or loss.
• Sebi defines short selling as a process in which traders sell shares even when they do not own them.
• These shares are usually sold in the market on margin (borrowed) money and bought when the price falls.
• Short selling can happen through any of these three modes: cash, options and futures.

How Is It Done?

• Let’s say a trader feels that the share price of XYZ company may come down.
• If the trader borrows and short sells 10 shares at Rs 100 per share in the cash market, he gets Rs 1,000 (not including tax) and has a liability of 10 shares.
• If the share falls to Rs 80 and the trader buys back 10 shares, he pays only Rs 800. The trader eliminates his liability with these 10 shares, while making a profit of Rs 200 (Rs 1,000-Rs 800).
• However, if the price of the share increases to, say, Rs 120, he pays Rs 1,200 to buy them back. Thus, after settling the liability of 10 shares, he would end up with a loss of Rs 200.

Things To Keep In Mind

• Remember that short selling is a difficult process and involves speculation. If you get it wrong, you may incur huge losses.
• Short selling is complex and usually undertaken by traders. Retail investors should, ideally, overcome the lure of making quick gains from it that unscrupulous brokers may promise them.
• It not only comes with the risk of incurring a loss, but also taking on debt as short selling is usually done on borrowed money.
• Intraday short selling can be done only in the cash market, whereas shorts taken through options and futures can be carried forward.