Know if can we sell shares without buying: The lure to make good money leads investors to start share market trading. Despite the fact that several people have made it big in equity trading, this is not at all easy. Investors are required to be disciplined and they should keep patience. Here too there are different ways of making money in the stock market.
Here traders indulge in short selling. Short-selling means selling a stock first and then buying later in the day. However, an amateur trader will generally ask, “Can we sell shares without buying?” The answer is yes. In this article, we will understand the concept of short-selling in detail and look at its pros and cons.
Quick Read: Stock Market Investing for Beginners & Dummies!
Can we sell shares without buying? A deeper look into the concept of short selling
Mr. Z knows that the price of the stock XYZ may fall due to the company’s performance in the recent quarter or because of global factors. He walks into a brokerage firm and discusses this. A representative informs that if he is sure that the price will fall, he can make money out of it.
The representative says that he can sell the shares now and buy them later in the day. Mr. Z asks, “Can we sell shares without buying?” The representative then explains the concept of short selling.
Short selling means a method in which investors sell shares or securities which are not owned by them or that they don’t have in their Demat account. Therefore, in these types of situations, traders can borrow the shares or securities from their broker by paying a margin fee.
It is the duty of the trader to return the shares that have been borrowed to the broker at the end of the settlement cycle. In stocks, the settlement cycle is usually a day.
The concept of short selling focuses on the premise that the price of a stock will come down and a trader can benefit from the fall in prices. If the price of a share that the seller has shorted declines, the seller can buy back the stock at a lower price to generate a profit. However, if the stock price rises, he has to buy it back at a higher price, which will result in losses.
Possible scenarios in shorting
Going back to our example, once Mr. Z short sells a stock, there are the following possible scenarios:
Favorable movement: He sells the stock and the movement happens as per his expectations. He sells 100 shares of XYZ company at INR1,100 and these shares are down to INR1,080. He can book profits of INR2,000 and close out his position.
Unfavorable movement: He sells the stock and the reverse happens. Upon selling 100 shares of XYZ company, he waits for the price to fall. However, the stock price goes up and Mr. Z incurs a loss. Since an investor has no idea how high a stock price can go, it is always beneficial to put a stop to loss.
If the stop loss is placed, then the position will get terminated automatically. However, an investor can close the position before the stop losses are hit.
Range-bound pattern: Mr. Z. places the sell order and the stock trades in a range-bound pattern. In this case, Mr. Z can choose to close his position to avoid last-hour volatility. Of course, there is a possibility of incurring some losses after he pays brokerage and statutory costs.
Making investments in stocks in the usual way is already risky enough. Short selling is even riskier. Most of the time, a short selling strategy is adopted by very experienced investors as these investors have large portfolios which can easily absorb sudden and unexpected losses.
Thus, in our example of Mr. Z where he asks if can we sell shares without buying, the answer is yes. However, shorting should be done strategically.
Timing is extremely critical when it comes to shorting stocks. Shares tend to decline at a much faster pace than they advance, and a significant profit in stock can be wiped out in a matter of days or weeks due to earnings misses or any other bearish development. The short seller needs to time the short trade so that perfection can be achieved.
Entering the trade late can result in a significant opportunity cost in terms of lost profits. This can be due to the fact that a major part of a stock’s decline may already have taken place.
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