Short selling means selling equity shares that are not owned by a seller and are also not present in the Demat account. These shares are lending to the seller by the broker with a promise that they will be delivered back to the broker at the time of settlement. Also, short selling happens when there is a bearish trend in the market and investors expect the prices of shares to fall.
The concept of short selling makes many traders uneasy but the fact is that more money can be made by short-selling than being long on any stock. Rationally speaking, fear supersedes greed, and prices always tumble down faster than they rise.
Legendary traders have made fortunes by short selling and history is full of such names. Jesse Livermore shorted the 1907 and 1929 stock market crashes and amassed multimillion-dollar fortunes. Nicolas Drava, though an impeccable investor said way back in 1977 “I have never done it myself because I am not psychologically cut out for short selling. But I think markets have now changed their character so much that all experienced investors must seriously consider it. It is not for the proverbial orphans and widows though”.
However, selling short can be costly if the seller guesses wrong about the price movement. A trader who has bought stock can only lose 100% of their outlay if the stock moves to zero. But the who have shorted stock can lose more than 100% of their original investment.
We can make money by short-selling if we short a stock using any of the following rules:
As a general rule, the best time to short is when the market is tanking. Any stock that has risen in a bearish market is a perfect candidate to short as it will eventually succumb to selling pressure and fall.
On the other hand, we have to avoid any stock to short in a bull market as even a weak stock starts rising in a bull market. We should also avoid shorting a stock when the market is choppy and indecisive.
Irrespective of the general market conditions, another good time to consider short selling a stock is when it comes out with its earnings reports.