Short selling is an action whereby one sells securities in the stock exchange without actually owning it beforehand. The idea behind short selling is to make money if the price of the stock goes down. This is an opposite of buying or going long, where the objective is to make money if the price of the stock goes up. In short selling, the downside risk is technically unlimited because the stock price may rise indefinitely. This downside risk is lower in case of going long; the risk is limited to the price of the security. Of course, there is the concept of circuit filter hitting that blocks and unexpected movements in the security.
In my quest to try something new, I decided to short sell 1 share of SBI. I gave a short sell order at 3081 hoping to make even a few rupees if it went down. I had no idea if it was the right day to do so, but I knew that my downside would be limited to a few rupees only. But before I could close the position, it was 15:30 and I was left with a -1 balance. And trouble started from there.
I got automated emails and messages about my negative balance. I didn’t know what to do. A call to Kotak securities helpline and some research revealed the process. It goes like this:
If the square off (or closure of the position) does not happen on that day, the scrip is called for auction. By auction it implies that the exchange will buy at whatever price it is available. It appears that this auction is a parallel market. Now, in case the price has gone above my sale price, I need to bear the loss. But if the opposite happens, I don’t stand to gain anything. Before being considered for auction, an amount to the tune of 150% of the short sale price is blocked, ie removed from the trading account till all adjustments take place.
The sad part: the scrip had gone down by the time the auction took place, but I didn’t get anything, but I had to pay a penalty (to the tune of a few rupees) for not closing my short positions. The actual calculations and the rules are in the link below.
And probably that is why stock prices rise due to traders ‘covering their short positions’.