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Further, investors are required to pay a hefty penalty charge to the clearing member for defaulting. It increases market efficiency and helps investors use the strategy for hedging, speculation, etc. To effectively use short-selling, investors should have a sound understanding of market dynamics like direction, volume, liquidity, volatility, etc.
Knowledge of technical analysis can be added advantage to understand this better. Retail investors with limited knowledge about the same should refrain from short-selling to avoid unnecessary large risk exposure.
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Short-selling enables investors to make a profit when markets are falling, and even protect their portfolio by hedging against market correction on the shorted stock and other stocks in their portfolio Therefore, it permits investors to use leverage to avail themselves of more opportunities for further investment and gain. By Malvika Saraf and Parthajit Kayal An investor can often bet against the rise of a stock price if he believes the share price is likely to fall.
Related News. By contrast, if the stock soars, there's no limit to the profits you can enjoy. It's quite common for long-term stock investors to earn profits that are several times the size of their initial investment.
With short-selling, however, that dynamic is reversed. There's a ceiling on your potential profit, but there's no theoretical limit to the losses you can suffer.
And if you think losses like this aren't possible, think again. Still, even though short-selling is risky, it can be a useful way to take calculated positions against a particular company for investors who know what they're doing. Managing your risk is important, but when used in moderation, short-selling can diversify your investment exposure and give you an opportunity to capture better returns than someone who only owns stocks and other investments.
As a final thought, an alternative to shorting that limits your downside exposure is to buy a put option on a stock. Essentially, a put option gives you the right, but not the obligation, to sell a stock at a predetermined price known as the strike price at any time before the option contract expires. So, the idea behind buying a put option is similar to shorting, although the most you can possibly lose is what you pay for the put option.
Now, there's more to trading options than I can explain here, so do your homework if this is a strategy that sounds appealing to you. But it can be a smart alternative to the unlimited loss exposure that comes with shorting a stock.
Her areas of expertise and research interest include legal and ethical issues in financial markets, entrepreneurial finance, and regulation of financial markets around the world. The Motley Fool: What are some common misconceptions about short selling that investors should know? Johan: I think most investors believe the risks to be the same as that of taking long positions. Definitely not the case.
Some risks are, of course, similar, for example trading on misinformation. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Your Money. Personal Finance. Your Practice. Popular Courses. Markets International Markets. Table of Contents Expand. What Is Short Selling?
India's Ban on Short Selling. New Short Selling Guidelines. No Naked Short Selling. Special Considerations. The Bottom Line. The practice was banned by the Securities and Exchange Board of India between and after insider trading allegations led to a crash in stock prices. Financial authorities require traders to identify short sales at the time of the order. Naked short selling remains illegal in India, along with day trading by institutional investors.
Indian regulators instituted a temporary ban on short selling between March and October because of economic turmoil of that year.
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