What is short selling and why is SEBI considering banning it?

• SEBI is considering banning short selling to control the fall of shares due to the coronavirus outbreak.
• Several countries have already banned short selling temporarily.

Short selling is a trading strategy in which an investor sells shares expecting their price to decline in the near future. As and if the price declines, the investor buys those shares at a predetermined price The difference between the selling price and the buying price will be the investor’s profit or loss.

What is short selling?

Think of short selling as the opposite of a regular purchase – in a regular purchase, you first buy the shares at a price and sell them at a higher price. In short selling, the shares are first sold at a higher price and then bought back at a lower price.

More or less, it is a bet like any form of trading but in this method, investors gain by betting that the stock price will fall.

Generally, short selling happens when investors expect the prices of shares to fall. This means that there is a bearish sentiment in the market. Essentially, short sellers are bears – they try to drive the price down to make a profit.

How does short selling work?

Let us understand short selling with an example.

Suppose the shares of a company XYZ are currently at ₹500. There is an investor in the market who expects the price to go down to ₹300 in the near future. This means that the investor thinks that the prices are currently high, so buying at this price is not an option.

So, to make a profit, the investor first sells 100 shares of XYZ at ₹500, so he has ₹50,000 from the sale.

When the price of XYZ’s shares come down to ₹300, the short seller buys XYZ shares by paying ₹30,000.

The difference of ₹20,000 is the investor’s profit.

A risky gamble

Short selling is a risky gamble – there is no limit on prices, so you can end up with unlimited losses. Shorting is where you guess the price of a stock on a date in the future, and agree to buy it. So one has to buy it even if the stock price is high!

If there is excessive short selling in the market, it also suggests that the bears have taken over and the share or the market could end up crashing, leading to losses for a lot of retail investors.

Why is SEBI considering banning it?

The National Stock Exchange and Sensex have crashed by more than 18% in March alone, wiping off crores of investor wealth in the process.

To keep the fall under control, the Securities Exchange Board of India (SEBI) is considering a ban on short selling, says a report by Business Standard. This would prevent bears from controlling the market and crashing it further.

Countries like the UK, Italy, Spain, South Korea have temporarily banned short selling in the wake of the coronavirus crisis.

See also:

Short sellers reaped $51 billion in 7 days as markets tanked on coronavirus panic

'Short selling should be illegal' - Elon Musk praised a crackdown on shorts by the world's biggest pension fund