Short Selling – Definition and Reasons Prohibited for Beginners

Contemporary, profitable and easy to do, the reason for investing is becoming the prima donna among Millennial and Z generations today.

Coupled with the presence of various online applications that provide access to playing investments online, making investment enthusiasts higher. And of the various assets currently available, it can be said that stocks are the prima donna.

Becoming very popular lately, stock investing is no longer a long-term savings, but many people have used it as a business or stock trading.

Because of this, there are many strategies, tricks, up to new types of transactions in stock investments that are used to get maximum profit.

Among the different types of strategies and stock buying and selling transactions, one type of transaction that is commonly used, although it carries a high level of risk, is the short sale.

What is short selling?

Short selling is a strategy commonly used by stock traders when trading. This strategy is known to be effective, but it can also pose a high risk if not carefully executed.

Short selling is an investment strategy in which investors borrow securities and sell them in the market with the intention of buying back the securities if the price falls and returning them at a lower value.

This investment strategy is based on speculation that a security will fall in price and is usually only carried out by experienced traders or investors. In Indonesia, short selling has another name, namely, short selling.

Short selling is a form of transaction made by investors using a stock lending system. The purpose of borrowing is to sell shares at a higher price. The hope is that if the stock price falls, those investors can buy it.

The main key to the success of this strategy is that short sellers must be able to spot market movements and predict when prices will fall. When the price has fallen, investors buy it back and return it to the stockbroker.

However, not all stocks can be traded using the short sale technique. Stocks that can be traded by short selling must be determined in advance by the Indonesia Stock Exchange (IDX).

In addition, from an investor’s point of view, there are a number of regulations that must be met in order to be able to carry out short stock transactions. Among them are:

  • Keep a regular securities account so that news of transactions can be known
  • Do you have a special account for short sales
  • Have deposited the initial guarantee with a minimum amount of IDR 200 million.

Short sale mechanism

There are several mechanisms that can be performed by investors in short sale transactions, including the following:

  • An investor or trader makes a stock loan to a broker of an investment firm regulated by the OJK.
  • The investor then sells the shares to someone else and keeps the proceeds in the investor’s account with the affiliated securities company.
  • Investors must complete this transaction by buying back the shares. Investors benefit when the stock price when buying back is lower than the stock price when the stock is borrowed from a broker. If the opposite happens, the investor loses.

Example of short selling

Mr Andhy is a stock investor looking to short Rp 200 million worth of shares. Because of this, he decided to borrow Rs. 200 million shares from XYZ company, where the price at the time was Rs. 20,000 per share. After borrowing, the shares are then sold in the market at a price of Rp. 20,000.

According to forecasts, the share price then fell to Rp. 18,000 per share. Mr Andhy, who had the money from the sale of the loan shares for Rp 20,000, then bought the shares and repurchased the shares for Rp 18,000.

Since Pak Andhy initially only borrowed shares from Company XYZ, the purchased shares had to be returned to the lender. So where did Mr Andhy’s profits come from? That is, from the difference between Rp. 20,000 and Rp. 18,000, that is Rp. 2000.

However, the risk that could arise is that the previously sold shares will not increase to Rp. 22,000 but increase to Rp. 22,000. This way, traders have to spend more to be able to buy and redeem the shares.

Advantages, pros and cons of short selling

Although not highly recommended, especially for novice investors and traders. However, the short selling strategy itself has several advantages that make many traders still use this strategy, namely:

  • Allows investors to profit from selling assets even when the market is not in good shape.
  • Allows investors to use leverage to gain more investment opportunities and profits.

Because the risk is high and not practicable by all traders and investors, short selling is a strategy and stock trading deal that has advantages and disadvantages. The advantages and disadvantages in question are:

Pro

  • The win rate can be 100% or more
  • Can be funded from debt
  • Short selling can be used for price hedging practices (protecting investor funds from losses)
    counter

Cons

  • High risk, high return, because the level of profit is high, the level of loss that investors can suffer is also high
  • Margin account required
  • The portion payable used for this transaction bears interest

One of the things that makes short selling quite difficult and poses pros and cons is the impact it can lead to an economic downturn and is only considered profitable for investors coming from large institutions.

Invest wisely for maximum money

Any stock transaction is legal as long as the nature of the transaction is legal and it is not a criminal or fraudulent act. Likewise, it is okay to use the short selling strategy. As long as you fully understand the risks involved, meet the requirements and have sufficient experience. If not, it is better to avoid this strategy.

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