Short selling in the stock market is the practice of selling shares you do not own and then buying them back at a lower price later to make profits. This is in contrast to the conventional method of first buying shares at a given price and then selling them at a higher price in the market.
Short-selling shares are typically done when the market is bearish. This means the market is on a downward trend, and traders expect the prices to keep falling. So, they go short in the share market and sell shares today to buy them later at lower prices.
You know what is short in the share market, but how does short selling work? More specifically, how can you sell shares you do not own? The answer is simple; you borrow those shares from your stock broker and then sell them in the open market.
Since you borrow the stocks, you must pay your broker a margin. This margin can be of two types — the initial margin and the maintenance margin. The initial margin is the amount you deposit with your broker to initiate the trade, and the maintenance margin is the sum you need to pay to continue holding your short position.
Short-selling shares come with the following benefits for traders.
You do not need a lump sum amount to start short selling. You can easily assume short market positions if you have the funds required for the margin.
Short selling in the stock market offers excellent scope for significant gains if stock prices plummet, as speculated.
If you have taken a long position in other stocks in the same industry, shorting can help you hedge those positions if the market becomes bearish instead of bullish.
Before you short in the stock market, you need to be aware of these risks or downsides.
Shorting can lead to losses if the stock price rises instead of falling. Since there is no cap on how much the stock price can increase, the potential for loss is technically infinite.
If you fail to pay the margin interest while holding your position, you will have to liquidate or exit the position, leading to possible losses.
Before going short in the share market, weigh the pros and cons of the position you’re considering. If unsure, you can always choose the conventional way and take a long position instead. While at it, you can even diversify into the US markets with the Fi Money app. The in-app explainers make investing easy, even for beginners. And the best part is you can buy top US stocks at zero brokerage fees.
Short selling in the stock market can be profitable if you plan your trades well — and if any speculation you make works in your favour.
Yes, short-selling shares are legal in India and most countries worldwide. Occasionally, governments may ban the practice of regulating the markets.
Globally speaking, some of the biggest short sellers include Jim Chanos, Michael Burry, Cathie Wood and George Soros. These market players often go short in the share market.