What is short selling in US stock market?

As a trader, you may be aware that you can make money in the equity market by purchasing and then selling stocks after the prices rise. However, did you know that some traders also attempt to gain profits by first selling the stock at a higher price, and then buying it back at a lower price?

This strategy is known as short selling, and it is a common practice in the US stock market. Since short selling allows traders to use any fall in stock prices to their advantage, traders usually use this technique in a falling (or bearish) market.

Demystifying the Short Selling Strategy

Short selling has been in practice in the US ever since stock trading began in the 1700s. However, due to unstable market conditions, the country banned the practice from 1812 to the 1850s, after which it lifted the ban. Then, during the time of the Great Depression in the 1930s, America again clamped down on short selling due to multiple extensive US stock market sell-offs.

Today, however, short selling is freely practiced in the US stock market. Traders primarily use it as a speculative strategy to profit from falling stocks. However, the technique is also sometimes used as a hedging mechanism to protect a trader from losses due to unexpected market movements.

If you’re not sure how this practice works, here’s an example to offer some clarity. Let’s say that a company’s stock price is falling. You can use this downward momentum to your advantage by first selling the stock, at say $100. Now, let’s assume the price then falls to $80 a few days later. At this point, you can buy the shares back at $80 and square off your position. So, the profit you will earn through short selling here would be $20 ($100 minus $80).

Highlights of Short Selling in the US Stock Market

Before you practice short selling stocks in the US markets, you need to keep the following factors in mind.

Margin Account Requirements and Interest

You need a margin account with a stockbroker to short-sell stocks. You also need to pay interest charges to the stockbroker for lending you the stock that you shorted. The interest is charged as a percentage of the value of the borrowed stock.

Minimum Maintenance Margin

You need to maintain the minimum margin, known as the maintenance margin, set by the Financial Industry Regulatory Authority (FINRA), the New York Stock Exchange (NYSE), and the Federal Reserve at all times.

Tax on Short Selling

You also need to account for the US tax on selling stocks. Short-term capital gains from short selling are taxed anywhere between 10% and 35% depending on your tax bracket.

Risks of Short Selling

While short selling stocks may appear very lucrative, it comes with certain risks. Firstly, if the stock price doesn’t fall according to your expectations, your losses can be steep. Also, when you short-sell a stock, you won’t be eligible for any dividends that the company may declare in the meantime, since you do not actually hold the stock.

To Short or Not to Short?

Technically, Indians are not allowed to open margin accounts with US stockbrokers. This effectively means that you cannot short-sell US stocks from India. That said, you can go long by investing in US stocks through Fi Money. Our intuitive investment app comes with a host of features that make your investment experience seamless and hassle-free. With Fi, you can purchase a range of US stocks at industry-best forex rates, without paying any brokerage.

Frequently Asked Questions (FAQs)

How does short selling hurt a stock?

When many traders resort to short-selling a stock, it creates significant selling pressure and may drive the price down.

Can you short in the USA?

No. If you’re an Indian trader, you cannot short US stocks. This is simply because Indians are not allowed to open margin accounts with US stockbrokers.

What is the meaning of short selling in the US market?

Short selling is the practice of first selling a stock in the market at a higher price and then buying it back later at a lower price. It is a trading technique that is usually used when the market is trending downward.

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