What is short selling?
Short selling is a a trading technique a trader uses to profit from the falling price of a stock. It is a technique of selling a stock without owning it, with the view that the price is likely to fall further and, hence, there is profit to be made by buying it back at a lower price.
When the market is bearish or in downtrend, it presents a window of opportunity for traders to make money by ‘shorting’ stocks with the hope that the market will continue to be bearish and this is where short selling comes into picture.
Is short selling dangerous?
To start with, traders should be aware that short-selling is trading and not investing. They should also be aware that trading requires lot of skills and discipline and there are risks involved with it. To find whether short selling is dangerous or not, let us look at some of the key points below.
- Historically, individual stocks and equity markets, both domestic and global, have moved upwards (short-term movement aside). Thus, if we agree that the direction of markets is generally bound upwards, then holding on to a short position for a longer time is betting against the historical trend of a market is very risky.
- A trader should always exit the market once the target is achieved or the stop loss is triggered. But as this discipline in market is against our natural instincts of fear and greed and lack of such discipline, makes the position riskier.
- Theoretically, one stands to make only limited profit on a short sell with chances of unlimited loss. This is because, the stock price can rise to any level, whereas the gain is limited since the stock price cannot go below zero.
In Indian equity markets, short selling is typically undertaken via the futures and options route, since short positions in the cash markets can be held only intra-day. One may not be able to carry forward short positions in cash markets, since stock lending and borrowing is yet to kick in a big way to facilitate short selling in cash markets. As for as the futures are concerned, the quantity or the lot sizes of the stock futures are so high that many are not aware of the huge risks involved in short selling such instruments.
To summarize, though short selling could a profitable strategy occasionally, it could result in substantial losses and it should not be used by investors or traders who are new to the market and who do not understand the dynamics of stock market.