SHORT SELLING (Syllabus: GS Paper 3 - Economy)

Context: The Enforcement Directorate has concluded, after a preliminary investigation into the Hindenburg Research report and the subsequent market crash, that a dozen companies including foreign portfolio investors and foreign institutional investors (FPIs/ FIIs) based in tax havens were the “top beneficiaries” of short selling in shares of Adani Group companies.

Short selling

• About: Short selling, or shorting, is a trading strategy based on the expectation that the price of the security will fall.

• While fundamentally it is based on the “buy low, sell high” approach, the sequence of transactions is reversed in short selling - to sell high first and buy low later. 

• Also, in short selling, the trader usually does not own the securities he sells, but merely borrows them.

• Traditional method: “Buy low, sell high” is the traditional investment strategy in which one buys a stock or security at a particular price and then sells it when the price is higher, thereby booking a profit. 
• This is referred to as a “long position”, and is based on the view that the price of the stock or security will appreciate with time.
• Process: In the stock market, traders usually short stocks by selling shares they have borrowed from others through brokerages. 
• When the price of the shares falls to the expected levels, the trader would purchase the shares at the lower price and return them to the owner, booking a profit in the process. 
• If, however, the price of the shares appreciates instead of falling, the trader will be forced to buy shares at a higher price to return to the owner, thereby booking a loss.