What is: Short Selling

Short selling (also known as shorting) is not very popular among Indian retail investors and I get lot of questions about short selling. So let me try to explain the concept of short selling in very simple language.

Short selling is when you sell a stock but you don’t own that stock. The reason you can sell those stocks without having them is because you don’t need to deliver them immediately. You can deliver them to the buyer after some time period, usually end of the current month or few months down the line depending on your contract.

Pretty much a definition; now let us take a very simple example from our shopping experience to understand the concept of short selling.

Short Selling Example

Let us say you are planning to buy some furniture from a showroom. When you step in, you realize that they only have few options for you to choose from the display area but they have lot more options to choose from the catalogue. The shop owner or sales people tell you that as they have limited space the option they show in the book is ready to be delivered in godown. You selected one of such furniture, which is available, but not in the display. You pay for it and they tell you that furniture of your choice will be delivered to you within one week.

Sounds pretty normal.

Now let us look at the same transaction from the perspective of the showroom. They actually do not have the exact furniture set of your choice ready in the show room and most possibly not in godown as well but they have actually sold the same to you. They have taken some time before they will actually deliver those items to you and within this timeframe they know they can manage to get it constructed and deliver.

So they actually sold good they don’t have it but they know they will be able to get the goods created in market and deliver in the stipulated timeframe.

How Short Selling Works in Market?

The same concept of shorting or short selling works in market especially futures market. You actually do not need to deliver the stock you shorted the same day but you can deliver that on the settlement day for your cycle period and this period is normally last Thursday of particular month.

Let us say you expect some securities may go down from the current levels and so you decided to short that particular stock. If the stock prices move as per your expectation, you buy the stock few percentages down your shorting price and make the delivery of your stock on or before the given timeframe to the buyer. This is short covering.

It can happen that stock price did not move as you expected. So you may have to buy the stock higher than your shorted levels and it is termed as short squeeze where you are forced to cover your short to minimize your loss.

Points to Remember about Short Selling in India

1. In India shorting is only possible in Nifty stocks in futures market. You cannot short stocks and hold your shorts over night that is not traded in futures market. This is not the case in other World market especially NASDAQ. You can short any stock you wish and buy back at later date.
2. Mutual Fund houses in India are not allowed to short the stock and they can only trade buying and investing majority of their money. They cannot even remain liquid below certain percentage of the total assets and so when market is going down and even if the fund manager’s knows, he cannot do anything.

Hope this helps fellow Indian retail investors understand short selling. Share your views in comments below.