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What is Short Selling? Research Team | Posted On Tuesday, October 15,2019, 05:46 PM

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What is Short Selling?



Short selling in India is selling shares you don’t own. Retail investors and institutional investors can indulge in short selling and make money. A short seller is basically a trader who believes that a stock would fall in price. This trader borrows stocks through the Clearing Corporation of an exchange like NSE or BSE and sells them hoping to buy them back at a lower price.

Profits are based on the price differential. (This is the difference between the selling price of the share and the price at which the share was bought back). In India, short selling in the cash market can be done only on intra-day basis. In F&O (Futures and Options) market, this can be held for a longer time.

If you want to dabble in short selling, contact your broker as exchanges like NSE and BSE facilitate such transactions. But, if you make a profit, you will have to pay short term capital gains tax of 15% on the profit.

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What is Short Selling?

Short selling is the selling of stocks which you don’t own in the demat account. These stocks are lent by the broker with a promise to deliver the stock back to the broker. The shares are then sold and the proceeds credited to your bank account. You have to close the position by the end of the day.

If the price of the stock you have to short falls, buy back the stock at a lower price and make a profit. If the price of the stock rises, you would be forced to buy it back at a higher price and suffer a loss.

In short selling, you borrow stocks from the broker and sell them.  When the price of the stock falls, you buy it at lower levels and make a profit. Shares are then returned to the broker.

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How to Short Sell in NSE Share Market?

This example should give you a clear understanding on short selling in NSE share market. Rajesh trades each day in the stock market. He has an account with a leading stock broker. Rajesh has capital of Rs 1.5 Lakhs which is cash in the trading account. With 5 times exposure, he can buy or short sell stocks worth Rs 7.5 Lakhs.

Rajesh believes shares of XYZ Co. would go down and short sells 250 shares at Rs 1500 a share. Now, Rajesh doesn’t hold shares of XYZ Co. in the demat account. Still he short sells the stock. The share price of XYZ Co crashes. He then buys 250 shares at Rs 1,450 a share netting a profit of Rs 50 a share. Rajesh has made a total profit of Rs 12,500 from the deal (This is Rs 50 *250 shares). Rajesh has to pay brokerage for the deal and taxes on the short term capital gain.

Short sellers love a bearish market and can make a lot of profits as stock prices tank. A short seller targets a set of stocks to make hefty profits in a bear market.

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Is Short Selling Risky?

Short selling is very risky and if you don’t know what you are doing, you can lose a lot of money. The degree of risk is really high in short selling. Let’s understand why short selling is risky. If you trade in shares, you only lose the money you have invested. If you have bought 1,000 shares of a certain company at Rs 50 each, you lose a maximum of Rs 50,000. (This is if the share price falls to nil which is highly unlikely).

In the case of short selling, the losses you make are technically, infinite as you borrow shares instead of owning them. This is because the share price of a company can rise to any limits meaning unlimited losses.

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Short sellers are often seen as villains out to destroy companies. They could resort to rumor mongering and other illegal practices, causing stock prices to fall. This is why the CEO of Tesla Motors, Elon Musk hates short sellers and believes short selling must be made illegal. It’s popularly believed that his tweets in August on taking Tesla private were just an attempt to destroy short sellers. Tesla shares jumped 11% after the announcement and short sellers lost more than $1 Billion overnight.

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