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What do we mean by Short-selling of Stocks? Is it ethical to sell stocks before you buy it !

What do we mean by Short-selling of Stocks? Is it ethical to sell stocks before you buy it !

What is short-selling?

Short-selling, in the context of the stock market, is the practice where an investor sells shares that he does not own at the time of selling them. He sells them in the hope that the price of those shares will decline, and he will profit by buying back those shares at a lower price. In India, there is no prohibition on short-selling by retail investors. Institutional investors —domestic mutual funds and foreign institutional investors registered with the Securities and Exchange Board of India (Sebi), banks and insurance companies — are prohibited from short-selling and are mandatorily required to settle on the basis of deliveries of securities owned and held by them.

How is short-selling beneficial?

Short-selling is considered an essential feature of the securities market not just for providing liquidity, but also for helping price corrections in overvalued stocks. Supporters of short-selling claim its absence distort efficient price discovery, gives promoters the unfettered freedom to manipulate prices and favours manipulators than rational investors. Securities market regulators in most countries, and in particular, all developed securities markets, recognize short-selling as a legitimate investment activity. The International Organization of Securities Commissions (IOSCO) has also reviewed short-selling and securities lending practices across markets and has recommended transparency of short-selling, rather than prohibit it.

Is there any drawback of short-selling?

of short-selling feel selling, directly or indirectly, poses potential risks and can easily destabilise the market. They believe that short-selling can exacerbate declining trend in share prices, increase share price volatility, and force the price of individual stocks down to levels that might not otherwise be reached. They also argue that declining trend in the share prices of a company can even impact its fund raising capability and undermine the commercial confidence of the company. In a bear market in particular, short-selling can contribute to disorderly trading, give rise to heightened short-term price volatility and could be used in manipulative trading strategies.

Will institutional investors in india be allowed to short-sell securities?

Sebi is working on a proposal to introduce a stock borrowing and lending mechanism. This will allow institutional investors to short-sell by borrowing shares. Under this arrangement, an investor A, who feels that a certain stock is overpriced, borrows those shares for a charge from investor B, who is willing to lend those shares. Investor A then sells those shares in the market, hoping that the price declines so that he can buy cheap and return them to investor B. 

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