Why Shorting Stocks is a Bad Idea for Long Term Investors

Do you have long-term stock market trade plans? If so, there are a few things you must know about short-selling trading if that is your current plan. While the stock market is constantly volatile, short selling can be exceptionally unpredictable. This is the reason why even big players have often reported losses while short-selling.
 

Although short selling is certainly an option, it’s not something to dive into without a solid foundation. Advancements with short-selling plans must be backed by strong market understanding and knowing the companies in which you are investing. So, unless you are sure of your move, it is better to avoid short selling. In this blog, we will break down the perils of trading in short selling and things you must be aware of.

• Short selling involves selling stocks first at higher prices and then buying them at lower prices. The margin price is the trader's profit.
• Short selling requires an in-depth understanding of the market, or you may end up incurring losses.
• Traders need to pay stock borrowing charges to the broker irrespective of their profit or loss.

In simple words, short selling is the opposite of regular trade. Here, you sell a stock at a higher price and purchase it later at a lower rate. The margin between the buy and sell price is your profit. Let's understand this with the help of an example:

Rema, a 32-year-old MNC employee, is planning to short-sell. Rema chooses to sell 10 stocks of Indian Oil at Rs. 25 each. So, the selling price is Rs. 2,500. Rema speculates that the price will fall. As predicted, the price of the stocks fell to Rs. 20 for each stock. Now, Rema purchases the same 10 stocks at Rs. 2,000. Here, Rs. 500 is the profit.

Short-selling trading is not a popular idea among stock investors. You may wonder why. Short selling is a part of intraday trading, where you need to sell and buy stocks on the same day. You cannot hold stocks to get the best price until the next day. So, at the end of the day, you may end up making a loss. However, there's more to this. Let's understand the risks involved:

• Same-day trading
  Intraday trading involves buying and selling stocks on the same day without holding them any further. When it comes to short selling, you need to sell the stocks on the same day. If you fail to do so, the broker will sell the stocks at the end of the market hours at any price. That's not good news for investors.
• The temptation to wait
  Stock trading is a matter of patience and quick decisions. In short selling, you may be tempted to wait a little longer so the price falls to your expectations. However, sometimes, it can be detrimental if the opposite happens.
• The short squeeze
  As per the trends so far, if a stock is shorted to a great extent, the prices will likely increase. This is known as a short squeeze. In such a case, the investor is only left with a choice to exit at a loss rather than wait further.
• Prices can go high
  The profit in short selling is based on the investor's prediction. However, if the price does not fall, the losses can become unbearable. This is because there is no limit on how high the prices can go. The higher the prices get, the greater your losses will be.
• Borrowing charges
  In short selling, the trader sells a stock first and then buys it. So, you basically borrowed stocks from your broker, who also borrowed them from someone else. In return, you need to pay the charges for borrowing the stock and the dividend to the shareholder. So, irrespective of your profit or loss, charges have to be paid. These charges can further add to your loss in case you incur losses.

Short-selling trading can be beneficial when you are able to correctly predict the price movement. Traders with a strong understanding of the market can be a part of short selling. However, it is crucial to understand when to exit and leave the zeal to wait a little longer. Such a situation can be a threat to your profit. Putting a cap on losses and making swift decisions is a must while short-selling, making it a bad idea for long-term investors.