What is Shorting in trading?
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- Updated On:25-Aug-2022
- Replies:1
Short Answer
Shorting is nothing but the process of making a profit while the market is down. It's where the process of selling shares occurs first, and then buying takes place. the selling is the shares that are lent to you by the broker.
Detailed Answer
There are different ways to make profits, and one way is by shorting. Despite its complexity, understanding it and using it extensively could reap exponential profits.
Shorting a stock is nothing but making profits from the bearishness of the stock market. Instead of buying a stock and then selling it to make profits, it's the opposite. Its where users can sell a stock that they don't have and then profit on the loss and buy it when it declines. Hence, making a profit on the loss is what shorting entails.
However, to explain this in detail, let's understand short selling or shorting with an example.
Shorting in Stock Trading - Example
Consider XYZ company that is trading for 500 rupees per share in the stock market. However, looking at the charts and other financials of the company, you realize that the company's shares are going to fall. Hence, you want to book a profit from this decline in stock prices. But how can you do so?
Its where shorting comes into the picture, where you tend to borrow the shares from your broker. The number of shares depends upon the availability of the broker. They often look into the stock inventory on the amount remaining, or they could look into their client's portfolio to lend the number of stocks you require. Thus, you order 1000 shares from your broker.
After finding the number of shares you require, the broker then lends you the shares to your Demat account. After this, you see that the XYZ company that we discussed did fall in price and is currently traded at 300 rupees after a week.
Therefore, because you bet that the stock prices would fall for the company, you did make a profit. It's where you call your broker and then tell them to buy the company's share at 300 rupees per share. The lent shares are then returned to the place where it was first borrowed, and the newly purchased shares are then credited to your account.
If you do the math, you realize that there were 1000 shares lent to you at 500 rupees each, meaning you invested 1000500 = 5,00,000 rupees. But once the share of the price hit 300 rupees, you bought the shares, meaning the lent shares were taken back by the broker, and you purchased it for 300 rupees meaning 3001000 = 3,00,000 rupees. Therefore, the total profit made from this is 5,00,000 – 3,00,000 = 2,00,000 rupees profit. From these profits, you would have to pay a commission to your broker, which is often small based on the profits earned.
Shorting in Trading
Its quite a complicated process as you need to have a different type of account comprising a margin account and other special features activated to execute shorting. But then the risk is exponentially high if you get your predictions wrong as the profits would keep rising, and you would have to pay considerable amounts back to the broker. However, do keep in mind that you would have to try this out to see how you can make money off this technique.
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