The Role of Short Sales in Securities Trading

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Short sale is a term used in banking and finance, which describes the sale of fungible goods or financial instruments, in particular currencies or securities for which the seller has a short period to effect a sale.

In order to meet the future obligation, the seller must cover himself from the settlement date through the purchase of goods or financial instruments. However, short sales are not possible in the financial sector.

When making short sales, there is risk of losing even more than 100% of the invested capital, since the shares have a limit to their gains. That is, those who buy stocks on the rise, face the increased risk of losing the entire amount originally invested.

For example, if you do a short sale of a share of $1,000, it may come within the repurchase cost of $ 2,500 implying a loss of 150% for the holder of the shares.

The earnings limit is also unfavorable. In a traditional stock, the value of such assurances can be multiplied many times against the initial investment. However, with a short sale the earnings limit equals the stock price since the shares have negative prices. That is, in an ideal situation, the investor makes a sale of a share of $ 1000 and the repurchase of $ 0, thus gaining 100%.

Short sales are principally engaged in short-term operations to take advantage of the fact that markets tend to experience declines in prices faster than increases. However, the most financial markets have a long-term upward trend and gain greater exposure for a limited period compared to traditional procurement limits associated with long-term investments.

A short sale in the form of a cash transaction differs to some extent with the extraordinary process of a sale. Provided that short sellers sold at market value within the prescribed deadlines, which usually falls between two to three business days.

And must therefore give the empty sales value in time. In the case of securities, they are usually carried out through a securities lending or repurchase transaction, and in the case of foreign currency, by analogy with a credit or a currency swap.

Under securities lending, the short seller is the owner of the borrowed security in a legal sense. A short sale is not defined by its legal ownership of the empty or non-property sales value.

Rather, the economic approach is based on the results from the sale of a short position, that is, whether the seller benefited economically from the transaction from a price decline in sales value.

For returning the loan, the short sellers sell at a future date in order to buy back value. If the price of the value has fallen by then, the seller will be paid a lower price, thus making a profit. However, if the price increases, the seller makes a loss since he has to stock up at a higher price.

Entering into a short position (short sale of a value) contains a risk-reward ratio (market risk), which is the exact opposite of the initial value. For example, the maximum possible loss is limited to the purchase price, while the chances are theoretically unlimited for a price increase.
 

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