What do we know about short selling?

What do we know about short selling?

Short selling involves the trading of a security that doesn’t belong to the seller or securities that has been borrowed by the seller. Short selling is promoted thinking that the security’s price will come down, enabling the purchase of that security at a lower rate in order to make profits.

Short selling is generally instigated by forecasts, or by the desire to safeguard the risk of keeping the same security or a related one for a long period of time. As the risk of loss for a short sale is substantially limitless, it’s advisable to be used by well-versed traders who are familiar with the risks rather than beginners.

For example, a trader forecasts that stock NQ trading at $50 will decline in price. He borrows 100 shares and sells them in the market. The trader is ’short’ of 100 shares of NQ since he sold shares that did not belong to him in the first place. The short sale took place because of borrowing shares, which the owner of the shares can demand back at any time. Continue reading further to find out about the short sale in detail.

Short Sale Metrics

The two main measurements that are used to figure out how a stock has been sold are

–       The going Short interest

–       The Shorting interest ratio

Shorting interest relates to the shares that are sold in shorting to the percentage of the shares that are remaining in the company.

Shorting interest ratio is the actual shares that are sold shortly split up by the usual volume of the stock.

Stocks having relatively high short interest and short interest rate are at greater risk of a ’short squeeze’ leading to ascending price projection. It’s a risk short sellers have to face constantly. Apart from the risk of facing losses, short sellers are also on the lookout for dividends that are paid by short stocks.

Additionally, heavily shorted stocks face an added risk of a ’buy-in’. It points to the fact that a short position for a brokerage can be shut down at any time if it’s hard to borrow the company’s stock or the lenders of the stock are demanding it to be returned.

Short Selling in Context

While short selling is mostly disparaged and short sellers have seen ruthless operators who damage companies, the truth is short selling enables liquidity to the markets and prohibits stocks from being proposed at higher levels. Although offensive short-selling practices are considered illegal, short selling done the right way is a great method for portfolio risk management.

Read More