What does selling short mean?

Answer 1

Short sellingYou "borrow" a stock to sell it at a high price, and hope it goes lower where you can buy it back and the difference in price is your profit. Remember that Stocks can only go to $0, but selling short can mean you have to cover your short and buy it at a higher price, and there the sky's the limit!

Short Selling is a Derivative Strategy that you can use to make profit when stock prices fall. Let us look at a Scenario.

Step 1: You expect that Shares of ICICI Bank are going to fall next week once their quarterly results are out. Lets say the current share price is Rs. 1000 per share.

Step 2: You Initiate a Short Sell request for 10 shares of ICICI in the Stock Market (You are selling 10 shares that you do not own). You will get Rs. 10,000/- for the sale transaction under the obligation that you will buy it back after some days.

Step 3: Lucky for you, the price of ICICI has indeed gone down after 2 weeks. It is trading at Rs. 900 per share.

Step 4: Now, you buy the same 10 shares of ICICI for Rs. 9000/- and settle the trade with your broker. This is what happens when you finish the buy

1. You literally bought back the 10 shares you did not own and now your broker has no fake shares on your name

2. You pay your broker the price @ Rs. 900 per share which is Rs. 9000 and complete the trade

Step 5: Since you fulfilled your obligation of buying back the 10 shares the Short-Sale transaction is complete. You got Rs. 10000 for the sale and paid Rs. 9000 for the purchase two weeks later, leaving you with a profit of Rs. 1000

In Short "You successfully sold shares you didn't own, then bought the shares back at a cheaper price, thereby pocketing a profit."

On the contrary, if ICICI had gone up to Rs. 1200 after 2 weeks, you still would have to buy back those 10 imaginary shares you sold thereby paying Rs. 12,000 to your trader which essentially means you are losing Rs. 2000 from your pocket. It would have been better if you had just purchased ICICI shares on day one instead of placing a Short-Sell order.

A point to note here is that, your trader will expect some Margin Requirements in order to fulfill such trades and the above is just a hypothetical example with no strings attached.

This is an extremely risky proposition. Novice or Risk Averse investors should stay away from such transactions because if the price of the shares go up, you still would have to buy back the shares at a later point in time and you will end up losing money instead of earning it