Additional Resources

  1. The Long Or Short Position [cba.unl.edu]
  2. Short Interest, Institutional Ownership, And Stock Returns [economics.mit.edu]
  3. The Good News In Short Interest [bschool.nus.edu]
  4. Short Selling May Affect Stock And Bond Prices [gsb.stanford.edu]
  5. What Is Accomplished By Banning Short-selling? [citeseerx.ist.psu.edu]
  6. Short-sale Constraints And Stock Returns [citeseerx.ist.psu.edu]

Definition

In finance, short selling is the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them. In the event of an interim price decline, the short seller will profit, since the cost ofpurchase will be less than the proceeds which were received upon the initial sale. Conversely, the short position will be closed out at a loss in the event that the price of a shorted instrument should rise prior to repurchase. The potential loss on a short sale is theoretically unlimited in the event of an unlimited rise in the price of the instrument, however, in practice, the short seller will be required to post margin or collateral to cover losses, and any inability to do so on a timely basis would cause its broker or counterparty to liquidate the position. In the securities markets, the seller generally must borrow the securities in order to effect delivery in the short sale.

Short Position

The Short position is often just termed as short and refers to the selling of a security which is currently not owned. This means that it refers to the sale of a borrowed financial instrument with the expectation that the asset will drop its value due to such transitions. It is also termed as selecting the sale option from a detailed options contract which allows an investor to make different decisions.

Explaining Short Selling

The practice of short selling requires the identification of securities that may be going down and then selling them without owning them. The short seller will repurchase these securities again and aim to benefit from the differences in prices that occur during the two phases.

Short selling can be described as a risky investment strategy. The short seller entirely depends on the belief that the security price will go down to make the profit. The short seller can also face an exponential loss if the prices of the security or the asset start to rise altogether. This is called a closed out situation where the short seller is in no position to make a profit with this technique.

Where is Short Selling Used?

Short selling is frequently used in the currency markets as well as in buying public securities. The method of short selling requires advanced knowledge of a financial market and therefore, short selling investors can be accused of using an unfair advantage, especially if they have a position in an important financial institution such as a stock exchange.

Short selling is also against the traditional practice of holding assets and waiting for their prices to rise in the coming years. This is a technique that is now termed as long selling as opposed to the principle of making an income from reduced prices.

Short selling requires a covering act because the securities that are sold are never bought and always remain in the ownership of the actual lender. This means that the lender can, at any time, ask for their securities to be paid back and usually the short seller then buys back the available stock of funds at a reduced price and makes a profit in between.

Problems with Short Selling

Short selling can create a very difficult position in a market which is already struggling as it promotes the market prices to go down further. The 2008 crisis in the United States showed that when large investors engaged in short selling, it became very difficult for companies such as Lehman Brothers and Morgan Stanley to maintain their businesses.

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