Risk of Short Selling:

We already know what is short selling. But let's make one thing clear: shorting is risky. Actually, we'll rephrase that. Shorting is very, very risky ... not unlike running with the bulls in Spain. You can have a great time, or you can get trampled. You can think of the outcome of a short sale as basically the opposite of a regular buy transaction, but the mechanics behind a short result in some unique risks.

1. History has shown that, in general, stocks have an upward drift. Over the long run, most stocks appreciate in price. For that matter, even if a company barely improves over the years, inflation should drive its stock price up somewhat. What this means is that shorting is betting against the overall direction of the market.

2. When you short sell, your losses can be infinite. A short sale loses when the stock price rises, and a stock is (theoretically, at least) not limited on how high it can go. On the other hand, a stock can't go below 0, so your upside is limited. Bottom line: you can lose more than you initially invest, but the best you can earn is a 100% gain if a company goes out of business.

3. Shorting stocks involves using borrowed money, otherwise known as margin trading. Just as when you go long on margin, it's easy for losses to get out of hand because you must meet the minimum maintenance requirement of 25%. If your account slips below this, you'll be subject to a margin call - you'll be forced to put in more cash or liquidate your position. (As mentioned earlier, we won't cover margin details here because we have an entire tutorial devoted to it.)

4. If a stock starts to rise and a large number of short sellers try to cover their positions at the same time, it can quickly drive up the price even further. This phenomenon is known as a short squeeze. Usually, news in the market will trigger a short squeeze, but sometimes traders who notice a large number of shorts in a stock will attempt to induce one. This is why it's not a good idea to short a stock with high short interest. A short squeeze is a great way to lose a lot of money extremely fast.

5. The final and largest complication is being right too soon. Even though a company is overvalued, it could conceivably take a while to come back down. In the meantime, you are vulnerable to interest, margin calls, and being called away. Academics and traders alike have tried for years to come up with explanations as to why a stock's market price varies from its intrinsic value.

They have yet to come up with a model that works all the time, and probably never will. Take the dot-com bubble, for example. Sure, you could have made a killing if you shorted at the market top in the beginning of 2000. But many believed that stocks were grossly overvalued even a year earlier. You'd be in the poorhouse now if you shorted the Nasdaq in 1999! This is contrary to the popular belief that pre-1999 valuations more accurately reflected the Nasdaq. However, it wasn't until three years later, in 2002, that the Nasdaq returned to 1999 levels. Momentum is a funny thing.

Whether in physics or the stock market, it's something you don't want to stand in front of. All it takes is one big shorting mistake to kill you. Just as you wouldn't jump in front of a pack of stampeding bulls, don't fight against the trend of a hot stock.

Note: From yesterday morning my computer system is not working and hence could not put my inputs on Shorting by the FIIs and could not reply to some irritating voices which I heard in a Finance Media Channel from yesterday morning.

The question which haunts my mind is that if scores of countries all over the world can ban Short Selling what is holding back SEBI to take this Stern decision to halt the downward market movement for the time being.

It will be dangerous and unfortunate if SEBI starts to believe the AGENTS Of FIIs who proliferate a TV channel these days and come up wtih some outlandish ideas in favour of not banning short selling.

If a patient is in ICU, we do not need to give him Vitamins to improve his health, but immediate drugs to control his acute problem, first. The rest of the problems can be dealt at later state.

A TV channel (who might have been PAID by those FIIs) is trying hard to make people understand great virtues of not banning short selling. Needless to say some arm chairm-analysts have also joined those agents of FIIs to fool the PEOPLE INTO BELIEVING THAT INDIA HAS GREAT CRISIS AHEAD.

Unless the government pulls up these kinds of motivated reporting by a section of the media, the India Stock market will continue to reel under selling pressure while the vested interest groups, will continue to use these media channles as their vehicles of money making.

I do not understand why the Sensex is down more than 900 points today when the Indian GDP is set to grow at 7.5% per annum.

Government should ban all these media channels and CLOSE THE STOCKS MARKWET FOR THE TIME BEING to control further depletion of the wealth of small investors.

I do not know if this wring could be published or not as still the Internet Connection is not upto the mark.