Share Market

Short selling is the selling of stock that the seller does not own. Yes, that is true. When we purchase stocks, you get to have a piece of ownership in the company. The buying and selling of stocks can occur with a stock broker or directly from the company. Brokers are used as they serve as an intermediary between the investor and the seller and often charge a fee for their services.

While using a broker we set up an account. The account is either set up as a cash account or a margin account. A cash account requires that we pay for our stock while making the purchase, but with a margin account the broker lends us a portion of the funds at the time of purchase and the security acts as collateral.

When an investor goes long on an investment, it means that he or she has bought a stock believing that its price would rise in the coming future. Conversely, when an investor goes short, he/she is anticipating a definite decrease in share price. In this context, a short sale is the sale of a security that is not owned by the seller, but which is promised to be delivered.

When you short sell a stock, the broker lends it to you. The stock there comes from the brokerage’s own inventory, from one of the firm’s customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. You will have to close the short by buying back the same number of shares and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference and if the price of the stock rises then you have to buy it back at the higher price, whilst lose money.

Although interest is charged on margin accounts, you can hold a short for as long as you want. With this you can keep a short sale open for a long time as it will cost more. However, one can be forced to cover if the lender wants the stock you borrowed back. Brokerages can’t sell what they don’t have. So in this case you will have to come up with new shares to borrow, or you will have to cover. This is known as being Called away. It happens rare, but is possible if many investors are short selling a particular security.