Do you know you can make a profit from the stock market even when the market is falling? In this blog post, I am going to tell you how to make a profit when the market is falling using the concept of short selling.
Table of Contents
Understand Short Selling?
Short selling is the process of selling a share instead of buying it first. In simple terms, you can sell the share without actually owning it. You can sell the share first and then buy it back at a lower price. By selling the share at a higher price and buying it back at a lower price, you can make a profit from falling stock prices.
Here you may ask, how can I sell a share that I actually don’t own?
The answer is: You can borrow shares from your stockbroker.
For example, if you are trading in Zerodha, you can borrow shares from the Zerodha broker and sell those shares in the market at higher prices. After a few hours, when the price falls, you can buy them back at a lower price and return the shares to the broker. This is called Short Selling
How Does Short Selling Work?
Let’s see the step-by-step process of short selling:
1. Borrow Shares: You borrow shares from your stockbroker.
2. Sell Shares: Sell those shares at a higher price.
3. Buy Back Shares: After selling, you buy back those shares at a lower price.
4. Return Shares: Once you buy back the shares, return them to the broker.
It’s as simple as this: Borrow, sell, buy back, and return. Let’s see an example to understand it better.
Short Selling Example
I am going to explain this concept using ITC stock.
Assume the current stock price of ITC is ₹500. You borrow 100 shares of ITC from your broker at ₹500 and sell them at ₹500. So, you sell ITC shares for ₹50,000.
You expect the share price of ITC to drop to ₹400. As you expected, the stock price drops down to ₹400. Now, as per your plan, you buy them back at ₹400. So, you buy back the 100 ITC shares at ₹400, spending ₹40,000 in total. After this, you return the 100 shares to your broker.
What will be your profit?
You sold the shares for ₹50,000 and bought them back for ₹40,000. So, your profit is ₹10,000.
This is how short selling works!
Also Read: Breakout Trading Explained
Another Example Using a Candlestick Chart
Let’s see another example using a candlestick chart. I have drawn a trend line and support line in this chart.
The stock price respects this trend line, so I sell 1,000 shares of the stock at ₹140. I borrow the shares and sell them at ₹140, amounting to ₹1,40,000. I expect the stock price to fall to this support level at ₹138.
As I expected, the stock price drops down to ₹138, reaching the support level. So, I buy back those shares at ₹138, spending a total of ₹1,38,000. After this, I return the 1,000 shares to the broker.
Do you know what will be my profit?
I sold the shares for ₹1,40,000 and bought them back for ₹1,38,000. So, my profit is ₹2,000.
You might ask what would happen if the price started to rise up Instead of falling down?
I tell you using the same example
I sold shares at ₹140, expecting the price to fall. But instead of falling, the stock price started to move up and reached ₹142. So, I buy back those 1,000 shares at ₹142. Now, I have to book a loss amounting to ₹2,000 because I sold them at ₹140 and bought them back at ₹142.
If the price doesn’t move as expected, you will have to book your loss amount. It is similar to normal buy-and-sell trading, but in reverse. Short selling is exactly the opposite of normal trading.
Important Note on Short Selling
Please be aware that short selling is allowed only in intraday trading, not in swing trading. If you are an equity swing trader, you cannot do short selling in swing trading. As you borrow shares from your broker, you need to buy them back on the same day itself.
Short selling is allowed only in intraday trading. If you want to do short selling in swing trading, you can do it in the futures and options market, not in the normal equity market.
I hope you understand this concept of short selling. If this blog post helps you, please share it with your friends. Also, share your experience in short selling and doubt in the comment box.