What is Short Selling?

Short selling is a trading strategy in which an investor borrows shares of a stock from a broker or another investor and immediately sells them, with the expectation that the price of the stock will decline. The investor hopes to buy back the shares at a lower price and return them to the lender, thereby profiting from the difference between the selling price and the buying price.

Here is an example of how short selling works:

Let's say an investor believes that the stock of Company X, currently trading at ₹50 per share, is overvalued and expects the price to decline. The investor borrows 100 shares of Company X from a broker and immediately sells them for a total of ₹5,000.

A few weeks later, the price of Company X's stock has indeed declined to ₹40 per share. The investor buys back 100 shares for ₹4,000 and returns them to the broker, pocketing a profit of ₹1,000 (the difference between the selling price of ₹5,000 and the buying price of ₹4,000).

However, if the price of Company X's stock had instead risen to ₹60 per share, the investor would have incurred a loss of ₹1,000 (the difference between the selling price of ₹5,000 and the buying price of ₹6,000).

Short selling can be a risky strategy, as there is no limit to how high a stock's price can rise, meaning potential losses can be unlimited. Additionally, short selling requires an investor to pay interest on the borrowed shares, adding to the cost of the trade. As a result, short selling is generally considered a more advanced trading strategy and is not suitable for all investors.