Summary:
A margin sell is a specified strategy where investors sell borrowed stocks and profit off subsequent price drops. Like most stock market strategies, margin selling comes with its own share of benefits and pitfalls. If you’re an investor willing to engage in margin selling, this blog can help clarify things.
A "margin sell" is also referred to as “short selling”. They refer to a transaction where the investor sells a stock in the market that is not originally owned in their brokerage account. Contrary to standard stock trading, investors can profit off the falling price of a stock with this trading strategy. In this blog, we will explore how margin on selling shares works and its other relevant details.
How does margin sell work?
To understand what is margin sell in stock markets, let’s understand the steps that lead up to a successful margin sale. Broadly, there are four steps to it.
- Borrowing Shares: The first step in triggering a margin or short sell typically involves an investor borrowing shares of a particular stock from another investor or their brokerage firm that is the real owner of the shares. The next step is the selling of these borrowed stocks.
- Selling the Borrowed Shares: The stocks are then sold by the investor in the market at their current market price. The entire premise of this transaction hinges on the stocks losing value in the future.
- Buying the Shares Back: In a bid to recover the sold borrowed stocks and cover their short position, the investor must buy the stocks back from the market at some point in the future. The success or failure of the endeavour is determined by the prices of the stocks at this juncture. The goal of the investor is to buy the shares back at a price that is lower than the price at which they were sold.
- Return the Borrowed Shares: Once the shares are brought back, they are returned to the lender whether another investor or the brokerage firm – whoever is the original owner.
As the process outlines, the investor makes a profit if the price of the stocks falls in future. Conversely, if the price of the stocks rises during the third stage, they end up incurring losses. The margin of the profit or loss is the price difference between the selling price in Step 2 and the purchase price in Step 3.
Pros and cons of margin selling
Like most market strategies, margin selling also has its own set of potential pros and cons. Below is a quick overview of its advantages and disadvantages:
Pros of Margin Selling (Short Selling):
- Profit from Price Declines: In traditional "long" positions, investors make money with rising future prices of stocks. In short selling, however, investors make money with the falling price of a stock in future. Thus, the primary advantage of margin selling is the ability of an investor to profit from falling stock prices.
- Hedging: Suppose you hold a stock that you believe has reasonable chances of incurring a decline in value. So you can choose to margin sell the stock that offsets your potential losses in the long position. Thus, margin selling is an effective hedging strategy that protects you against incurring losses in a long position.
- Portfolio Diversification: With margin selling, investors can profit from both rising as well as falling markets. This helps potentially mitigate the overall portfolio risk with a significantly more diversified trading strategy.
Cons of Margin Selling (Short Selling):
- Unlimited Losses: The entire deal with margin selling hinges on the stock losing its value in the market. If, on the other hand, the price of the stock rises significantly, you will have to buy it back later and incur substantial losses in the process.
- Borrowing Costs: Margin selling stocks involves borrowing shares from a third party, usually another lender or your broker. This process comes with its share of additional charges and interest costs. You must be careful so they don’t end up eating into your profit margins.
- Margin Calls: A margin call is a directive from your broker to deposit additional funds into your account. This serves as a cover if the price of the stock rises significantly, and the potential losses become too much. If you fail to meet the margin call of the broker, this may result in the liquidation of your position and portfolio.
- Limited Availability: Several stocks are subject to regulatory restrictions and even bound by hard-to-borrow fees. This limits your scope significantly making it more difficult to execute margin sales.
- Market Risk: Price variations can be more erratic and unpredictable in fast-changing markets. This makes margin selling a highly risky proposition with the potential for significant losses.
In Conclusion
Despite its apparent benefits, you must understand the risk associated with margin on selling stocks and approach it with caution. As the blog outlines, margin selling can be speculative and risky with no set ceiling to potential losses, especially if the stock's price goes higher than anticipated. Also, investors trying to cover potential losses in a short position may be required to post additional collateral as a margin. Finally, several stocks come with inherent restrictions on margin selling that are imposed by exchanges or the regulatory authorities. Investors willing to venture into short selling should, therefore, consult financial advisors to judge their best positions.