Discussion on SHORTING
vs BUYING stocks
WHAT IS SHORTING
WHEN YOU BUY...
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 SHORT...
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.
ALSO REMEMBER THIS:
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
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.
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.