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What is Short Selling and How to Benefit From It?

Apr 17, 2008
Short Selling is a strategy in which a trader sells a commodity or security that he or she does not own in order to profit from a falling market.? In this trader will borrow the commodity or security from his broker, who usually in turn has borrowed the shares from some other investor who is holding his shares then immediately sell on to the buyer. At a later date, the trader must buy back the commodity or security from the market to close the position.? If the value of the commodity or security has fallen during this period the short selling trader?s profit will be the difference between his original sale price and the buyback price.

Short selling is strategy to express bearish view point of trader towards a commodity or security. Essentially this is another face of coin in any freely traded commodity where trader feel that current value of commodity is inflated and does not represent actual value. This is exact opposite to more known buy and hold bullish strategy where investor buy the commodity or security feeling it be undervalued and will increase in price.

Short sellers need to be aware of three important aspects which can affect profitability of their short positions.

1. Interest on Borrowed Security ? As the commodity or security is borrowed from broker or third part account so interest is required to be paid on that. This is generally not applicable if you are settling your account on same day but can erode profits if kept on rollover for long duration. Depend on brokerage firm it percentage can change but generally it?s around overnight interbank lending rate.

2. Dividend Distribution ? If the security which is been shorted by trader gives out dividend then short seller need to short the dividend i.e. the dividend amount will be taken out from his brokerage account. So it is very important to keep track of dividend date of security trader want to short.

3. Short Squeeze - A short squeeze results when the price of the stock rises and investors who short-sold the stock rush to buy it to cover their short position. As the price of the stock increases, more short sellers feel driven to cover their positions and this result in further escalation of price in short duration of time.

Markets in all developed economies provide easy short selling procedures where individual shares can be shorted and rolled over for multiple days but currently in Indian Stock Market short selling of shares is only possible on intraday bases. If traders who want to take bearish view of certain scripts for longer duration they can do it through futures market. It is to be noted that availability of scripts in futures markets are very limited as compare to overall number of traded scripts.

When the underlying market is in downtrend, short selling is the best strategy if implemented correctly in hands of Commodity, Equity and Forex traders. To be a successful trader one need to learn both long and short strategies as market itself goes through bullish and bearish cycles periodically giving plethora of opportunities to generate wealth.
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