Short selling is the selling of a stock that the seller doesn’t own in order to buy it back once it has fallen in price, netting a profit in the process.
Basically a hedge fund or large investment bank takes the view that shares in a particular company are set for a fall. The investor then borrows the shares from someone who does own them – most often a large pension fund or insurance company – and sells them in the market. Once the shares have fallen in value, the investor buys them back at the lower price and returns them to the lender.
Example
- Assume shares in “Company A” currently sell for $10 per share.
- Short seller just borrows (he did not paid any money to the owner of the share) 1000 shares of “Company A” and sells for $10,000 hoping that that price will go down.
- Now , short seller has net cash of $ 10,000 in his trading account and he has to owe 1000 share of “Company A” to the actual owner, which he borrowed.
- As per short seller’s hope price went down, say $8 per share. He buys 1000 shares back from market for a price of $8 (Paid only $8,000 )
- Short seller returns 1000 shares of “Company A” to the actual owner and profited $ 2,000 easily (10,000 – 8,000 = 2,000)
- NOTE : If the price goes up short selling has the potential losses as well,
[ Short selling ]