You may have heard the word Short Selling in the context of stock markets many times. Big investors and hedge funds use short selling often. Short selling is the practice of selling a stock which you do not own expecting it to fall and later buy it back to return it to the original lender.
Sounds confusing ? Actually it is not. Your broker lends a stock to you for a fee. You do not have to invest a penny in the beginning. When you sell the shares, the proceeds from those stocks will be credited your account. Later, you have buy the same quantity of shares back because you have to give it back. If the share price goes down, you will get profit and if share price shoots you have to sustain the loses. This process of giving the stocks back to the lender is called covering.
An example will make it more clear. Suppose you want to short sell stocks of a company named XYZ Bank. The current price of the stock is Rs. 500. You borrow 100 shares from a broker and sell it in market. The sum of 50,000 is credited in your account. Later the price of the stock dips to 450. You buy back 100 shares which costs you Rs 45,000 and give it back to your lender. This give you a neat profit of Rs 5,000 minus the lender's fee for giving you stocks to short sell.
Needless to say, short selling is a very risky affair. In the above example, if the price of XYZ Bank shoots up to 550, you stand to lose. Short selling is done with the aim if speculating and hedging. This works in an overpriced market which is likely to fall soon.
