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What is meant by short selling, its advantages & disadvantage

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Short selling is sale of shares which a trader does not actually own at the time of trading. It is a technique used to gain advantage from the falling price of a stock. The selling of stock without owning it is done with an expectation that prices are very much likely to fall further and there will be profit in buying it back at a lower price. This is a very risky technique and is usually practiced by gamblers, arbitragers, hedge funds, speculators.
To facilitate traders selling stocks without owning their stock brokers buys stocks and further lends it to them, sell it and credit their demat account and trading account with the proceeds. For this trader needs to pay some transaction fee. Also he has to promise to buy the stock in future to return the loan which is called as covering the short.
Advantages of short selling
  • Like many other derivatives contracts short selling allows to earn profit with minimum capital as you only need to pay transaction fee to your stock broker.
  • When market is bearish this is one of the few technique which helps in making money.
  • Short selling minimizes the risk which trader takes as they do not need to buy/sell actually, rather just trade electronically and get benefited from market fluctuations.
  • It opens an additional source of revenue and liquidity for traders.
Disadvantages of short selling
  • It is only beneficial if price falls as it was expected otherwise traders ends up by earning negative return for themselves.
  • It has worse effects on stock market as a whole and for economy as well.
  • Short sellers can only trade in round lots i.e only blocks of 100 shares can be short sold.
  • Most of the securities that trade at low price are not listed on major indexes of stock market.
Risk associated with short selling
  • The loss is unlimited here. The price of stock may keeps on increasing and short seller will have to pay the price to buy back the stocks.
  • A short seller has to pay earning on borrowed stocks as long as his position is open in market. In case company declares dividends then he has to pay that amount to lender which makes the entire trade unprofitable.
Like every other trading technique short selling also requires market timing. Traders who are less skilled or new to trading should avoid using it as huge risk is involved. It can be concluded by saying short selling stocks can be profitable with right market timing . If prices do not fall as expected then it will lead to unlimited loss.
Pehla trade is among growing discount brokers. You can open free demat account with us and trade by paying flat Rs1/executed order for starting one month. Join us to trade in an cost efficient manner by saving your huge brokerage cost.
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