Short selling helps you to benefit while the stock price goes down. To those who are fresher, it seems unlikely. However, it does exist.
How?
You take out a loan from the broker and borrow shares. Yes, borrow rather than buy.
This borrowing entails paying a small amount of interest.
You must now return these shares to the broker at a fixed time in the future (remember, you borrowed the stocks, not bought them).
So here is what you do:
- Take shares
- Get the money by selling them at the current price.
- If the stock price falls, you buy the same amount of shares.
As a consequence, you now own the same amount of stocks that you borrowed. You, on the other hand, charged a lower amount. Your gain is the difference.
- The stocks are returned to the brokerage.
It’s finished. You profited from stocks that were declining in value.
What could possibly go wrong?
A lot of things can go wrong.
What happens if the stock price begins to rise?
Then you’ll have to buy the stocks at a higher price, because you’ll have to return the stocks you borrowed no matter what.
There’s a bigger real question.
A stock’s price can go as low as 0 and then stop, but there is no limit on how high it can go.
This means that if you were trying to short a stock and it started going up instead of down, your losses are potentially limitless.
Hedge Funds
Hedge funds operate in a similar way to mutual funds. However, there are several notable distinctions.
-They handle the funds as well as pool it from investors. Hedge funds, on the other hand, mainly attract wealthy and very-wealthy investors.
-They both put money into it. Hedge funds, on the other hand, are much more transparent and have a lot more freedom than mutual funds, which have very limited and specified investment avenues.
Hedge funds are known for doing a number of things, like Short selling of stocks.
They mainly short stocks of companies that are underperforming or whose stock prices are expected to decline.
A short squeeze happens when the price of a stock increases, allowing those who were shorting the stock to lose money.
A short squeeze can occur for a variety of reasons: a rumour, a brief increase in expectations, noteworthy news, and so on.
It’s occasionally (and incredibly rare) that it’s done on purpose.
Piggly Wiggly incident
Piggly Wiggly, a self-service convenience store, first opened its doors in 1919. Since they didn’t see any value in the stock, some major investors began Short selling it.
The company’s founder wanted to fight.
He took out a $10 million loan (a large sum at the time) and began purchasing his shares. As a result, the price rose, and the shorts suffered major losses.
Unfortunately, things did not work out well for him, as stock trading was stopped and the founder went bankrupt.
Something similar happened with the Tesla stock, although unintentionally.
But nothing (absolutely nothing) compares to what happened in the US markets in January 2021.
Game Stop Incident
Many young people in the United States have an adverse view of hedge funds.
A group of investors planned to begin buying the stocks of two companies after reading a Reddit thread. Some major hedge funds had been Short selling these two companies’ stocks.
The two companies were GameStop and AMC.
Some hedge funds incurred losses of up to 30% of their net capital.
The small-time buyers were mainly young people who were buying stocks for the first time.
Many in the financial sector, like Elon Musk, have publicly celebrated this short squeeze.
There were calls for a similar movement in India on some online groups in India.
Investors in India, on the other hand, are less concerned about such a situation.
What is the explanation for this?
For whatever it is that they are reviled for in the United States, they do not do so in India.
It’s simple. Our laws are highly strict.
Yes, Indian laws are better at avoiding misconduct.
In India, brokers and funds are strictly regulated and their power is highly restricted.
The positions you can hold and the leverage you can use are both minimal. Brokers hold US stocks, while Indian stocks are held in your demat account, which is different from brokers. Indian brokers are unable to sell or exchange orders.
The list is very lengthy. These are just a few points.
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