Short selling allows you to sell securities or shares that you do not have in your margin account. You can borrow securities or shares from your broker in such cases by paying a margin charge. Your broker will require you to return the borrowed shares at the end the settlement cycle. This is typically a day for stocks, and a longer time for currencies, futures, and options.
Short selling is based upon the assumption that the price for a security will fall and that you can profit from this decline. You normally hope that the stock prices will rise so you can make a profit. In short selling, however, the goal is to profit when the prices fall by selling shares you don't own. It may sound strange, but this is short selling!
7 steps can help you understand short selling on the share market
1. Create a margin account
2. Look for stocks whose stock prices are expected to fall
3. Borrow stock from your broker
4. Sell the stock
5. Purchase the exact same stock prior to settlement
6. Return the stock to your broker
7. As your profit, keep the difference between the selling and buying prices.
Let's now see how short selling works in the stock market using an easy-to-understand example.
Harish heard that ABC Bank was in serious financial trouble. He expects the stock's price to drop. Harish calls his broker to tell him that he would like to sell 100 shares of ABC Bank. Harish's broker must find 100 ABC Bank shares and loan them to him in order to fulfill his order.
The broker then checks his stock portfolio and that of his clients. If they are still not found, he can ask other brokerages to sell them the shares. Harish's broker finally finds the shares in a client's portfolio and sells them to Harish. It was Rs. 150 at the time he sold 100 ABC Bank shares. 150 per share The broker credit Rs. Harish has 15,000 in his brokerage account.
Harish's prediction was right in the middle of the day. It plunged to Rs. 120 as bad news quickly spread about ABC Bank's financial problems. 120 per share. Harish calls his broker again and asks him to fill in his position in ABC Bank. Harish's broker funds are used to purchase 100 ABC Bank shares from the market at the current rate of Rs. The total cost of the shares is Rs. 120 each. 12,000. 12,000.
Harish sold 100 shares of ABC Bank to Rs. Harish bought the shares back for Rs. 12,000 making a quick profit of Rs. 3,00 Harish will need to pay a small margin to his broker to be able to borrow the stock.
The share market short selling offers higher returns by only spending 20-25% of stock's actual cost. But, there are high losses. You can buy stock for Rs. Your losses are usually limited to Rs. 10,000 if you buy a stock for Rs. 10,000 is the limit. Short selling is a risky business. You never know how high a stock will rise in the course of trading.