What is Short selling & how it works?

by Anjali Sharma
22 April 20243 min read
What is Short selling & how it works?What is Short selling & how it works?
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Have you ever wondered if you expect the stock price to go up and then the choice lies in two simple answers, first is either you buy the stock for delivery and hold it in your Demat account or you buy the futures, if available in F&O. But, what if the stock is not available on F&O? Yes, here’s where the term Short selling fits on.

Short Selling- Meaning & Role:

Short selling is a trading technique that ventures on the decline in a stock or other securities price. It is a cutting-edge strategy that should only be undertaken by experienced traders and investors. Traders may use short selling as theory, and investors or portfolio managers may use it as a hedge against the downside risk of a long position in the same security or a related one. Presumption carries the possibility of considerable risk and is an advanced trading method. Hedging is a more common transaction involving placing an offsetting position to curtail risk exposure.

In short selling, a position is opened by borrowing shares of a stock or other asset that the investor thinks will decrease in value by a set future date—the expiration date. The investor then sells these borrowed shares to buyers willing to pay the market price. Before the borrowed shares must be returned, the trader is betting that the price will continue to decline and they can purchase them at a lower cost. The risk of loss on a short sale is theoretically limitless since the price of any asset can surge to infinity.

How does short selling work?

Short selling is selling stock and then buying it back before the end of the trading day, for which you’ll get a 4-6 hours window to close out the position. Short selling is deployed when you anticipate the stock price to go down during the day. Short selling takes place in three steps:
Selecting the MIS (Margin intraday square-up) option is a must while placing the sell order which will tell the system that it is a short-sell order.
Intraday order implicates payment of margins. Regardless, margins can be lessened by placing a Cover Order (CO) or a Bracket Order (BO). In a CO, you add a stop loss and in BO you add stop-loss order and profit target.
Short selling orders (intraday) have to be mandatorily closed out the same day. Brokers run an RMS check and closeout pending orders automatically.

Ideal conditions in short selling

There are three possible scenarios when you short sell out-
You sell the stock and it goes down. For example, you sold 500 shares of HCL at Rs1,100 and are down to Rs1,080. You can book profits of Rs10,000 and close out.
You sell the stock and it goes up. If the stop loss is placed then it eliminates the position automatically. You can also stop out earlier to cut losses.
You place a sell order and the stock does nothing for the first 4 hours. You can decide to close out to resist last hour volatility. Of course, you may lose some money after brokerage and statutory costs.

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