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Discussion on SHORTING vs BUYING stocks

WHAT IS SHORTING
  • The essence of shorting is that it allows traders to profit from price declines as opposed to price increases.
  • Although shorting allows you to profit from the decline of a security, the potential losses from shorting are theoretically unlimited, and the potential gains are limited to the value of your short.
  • Be warned: shorting involves risks not inherent in buying.
WHEN YOU BUY...
  • When you buy a stock, your maximum loss is limited to the amount you have invested. But your potential profit is unlimited.
  • If you don't care about STOPLOSS, and just let-go, at the end of the day even if the price of the stock goes down to Rs.0 per share, you will only lose the total value of what you put into the share.
  • Suppose you 'buy' 200 shares of ABCXYZ at Rs. 120/- each expecting rise in prices. Value will be (200x120=) 24000 and your investment will be (24000/4=) 6000. At the end of the day, if you have not taken any steps and the price comes crashing down to Rs.1/- per share, your position will be squared off automatically and your loss will be (120-1=) 119 per share. Total loss: (200x119=) 23800.
  • However, if prices start to increase there is no limit to how far it can go up to — it is quite possible it went up to 500 by closing time giving you a profit of over (200x380=) 76000.
WHEN YOU SHORT...
  • Shorting carries the exact opposite payoff. As discussed above, while prices increase, a stock's price can become double, more than double. In percentage terms, the upward range can be 100% and more — can be 200%, 300%, infinity. But when prices go down it can maximum go down to zero. Price cannot become negative. Therefore, in percentage terms, maximum decrease in price can be 100%.
  • Hence, in terms of profits in intraday trade, theoretically there is no limit to the profits you can make while if you go LONG. However, maximum profit when you go SHORT can be 100%.
  • Exact opposite happens in terms of loss in intraday trade — there is no limit to the loss you can make while if you go SHORT.
  • Suppose you have 'sold' those 200 shares of ABCXYZ at Rs. 120/- per share expecting prices will go down. Again, the value is 24000 and investment is 6000. If prices actually go down, the maximum it can go down to is Rs.0/- per share. In that case your maximum profit can be that 24000.
  • If prices go up instead, there is no limit to how far it can go upto till the end of the day. Prices can become double, 3-times, 4-times. Your loss will be limitless.
  • Shorting is, therefore, more risky.
ALSO REMEMBER THIS:
  • Prices fall very fast — normally it takes a lot more time for prices to go up by the same margin.
  • SHORTING has this advantage: you finish off with your deal quickly. In and out in a jiffy. The flip side is, you have to be real quick to make a killing. All in all, going SHORT is risky business.