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Short Selling and Stop Loss Orders

Posted on 11/21/2009 07:56:00 PM by Abhijeet Bhagat

Short Selling and Stop Loss Orders

Let's understand...
 Short Selling and Stop Loss Stock Orders

Recently there has been an exponential growth in the stock market awareness. There are certain words that are constantly bothering new investors 'Short Selling' and 'Stop Loss' or 'Stop Loss Orders' being among them. Since I saw many queries being posted on various blogs, portals etc. This article is an attempt to explain these terms in an easy to understand manner with animated presentation.

If you are...

  • New to 'Stock Market'

  • Have a feeling that stock market is a gamble.

Then... this article is not for you.
Before proceeding further I highly recommend that you grasp the Basics of Stock Market.

References :
Further... What is Short Selling

Still with me? Okay let's proceed then.The 2 terms Stop Loss Orders and Short Selling being related to each other in some way hence I have chosen to write on these two terms.

Short Selling :
Short selling is a concept where in you sell stocks that you do not own. I SELL STOCKS THAT I DO NOT OWN? yes you read that right. This is very much possible with the account with your broker where the broker lends you some stocks for a limited period of time.Such accounts are called Margin accounts.

Why would a person do Short Selling? Well to earn from falling market, EARN FROM FALLING MARKET? yes you read that right again..See the presentation.

Stop Loss Orders are executed in following 2 situations:
  1. BUY and SELL
  2. SELL and BUY
BUY and SELL situation :
  • You anticipate market may go up
  • X Co. is trading at 100
  • You place a Limit order of 105
  • if everything works okay your order may execute at 105 and you earn a profit of 5%
  • Your order was executed and everything looked okay
  • BUT...
  • if market starts falling .... what do you do?
  • You issue a Stop Loss order of 103 with a Trigger price of 104
  • The moment Trigger Price of 104 is reached your order becomes a normal Limit order and is likely to sale at 103
So you have limited your losses in above case.
SELL and BUY  situation :
  • You anticipate market may go down
  • You short on X Co Shares which is say trading at 100 now
  • i.e. You sell the shares at 100
  • You are supposed to return back the shares to broker since you have short sold the Shares
  • since you anticipated that market may go down you'd buy the shares at 95 and gain 5%
  • Instead!!! market started climbing up... now what????
  • You issue a stop loss order with Limit of 101 and trigger of 101.1
  • The moment 101.1 price is reached the order become a normal Limit order and you'd buy the shares at 101
  • hence you again limit your losses.

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