Short Selling is a well-known jargon in the stock market trading across the world markets. If you are an experienced investor, you may be knowing a thing or two about it. But if you are a beginner, it is essential to know how this concept works and what are the restrictions around it. Is Short Selling allowed in India? But before we answer this question, let’s first understand the meaning of the term – Short Selling.

What is Short Selling?

When an individual sells a stock without owning the share, it is called Short Selling. It is the sale of a security borrowed by the seller. The sale comes with a promise to buy back the shares later. An individual short-selling a stock has to mandatorily provide the shares at the time of settlement.

Short Selling is carried out with the belief that the price of a security will decline, which enables it to be bought in the future at a lower price to earn a profit. This strategy pays off only if the price of the security drops from the date of sale to the date of repayment.

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The opponents argue that the concept of short selling leads to market recessions and declines. They argue that it can trigger a sale spiral and crash the share market, eventually damaging the economy. They believe that short selling leads to manipulation in the market and the short-sellers try to artificially dampen the prices of certain equities. Some critics suggest a ban on short sales to ensure stability in the market. These are some of the reasons a country may ban short selling. This blog will discuss short selling in India.

Important Notes

  • Short Selling is the selling of a borrowed security with the intention of buying it later at a lower price.
  • This strategy was banned by the Securities and Exchange Board of India between 2001 and 2008 after the crash in the stock market due to allegations related to insider trading.
  • Between March 2020 and October 2020, a temporary ban was put on short selling in India due to the economic turbulence caused by the pandemic.
  • As per the guidelines by financial authorities, the traders need to identify the short sales at the time of the order.
  • Day trading by Institutional Investors is banned in India.
  • Naked Trading is banned in India.

Details about Short Selling Ban In India

The short-selling strategy was banned in the 1st decade of the 21st century in the South Asian Nations. In India, it was banned by the Securities and Exchange Board of India (also known as SEBI) in March 2001.

The reason behind the ban was the crash in the stock market due to the allegations on the then-president of the Bombay Stock Exchange (BSE) – Mr. Anand Rathi. There were allegations that he used confidential information from the surveillance department of the exchange to make personal gains and contribute to the volatility in the market. Later, Mr. Rathi was relieved from these charges by SEBI.

The complete ban on short-selling was short-lived and the Retail investors were allowed to short sell after the 2021 ban. The Securities and Exchange Board of India (SEBI) allowed Institutional Investors, like mutual funds, to short sell in the market in 2005.

Modified Short Selling Guidelines

In July 2007, SEBI issued new short-selling guidelines for institutional investors. 7 years after the short-selling was banned, the financial authorities allowed the institutional investors and retail investors to go short in 2008.

As per the new guidelines, the Institutional Investors were expected to reveal upfront at the time of placing the order if the transaction was a short sale. Even the Retail Investors had to do the same by the end of trading hours on the day of the transaction. As per the new short-selling guidelines, the Institutional Investors were banned from taking part in Day Trading.

The Securities and Exchange Board of India (SEBI) also brought a Securities Lending and Borrowing System, an automated and screen-based order matching platform. Using this platform, the traders would borrow stocks and honor their sales. All types of investors were allowed to participate in the program and carry out short sales. In day trading, the trader needs to square off the transactions on an intra-day basis.

Naked Short Selling is Banned in India

The SEBI has lifted the ban on short-selling in India but Naked Short Selling is banned in India. It occurs when the seller doesn’t deliver shares within the settlement period. The investors are required to deliver the shorted securities at the time of settlement.

Naked Short Selling or Naked Shorting is an illegal practice of short-selling shares that have not been determined to exist. The traders must borrow the stock or determine that it can be borrowed before they sell it short.

According to the note published by SEBI, “The stock exchanges shall frame necessary uniform deterrent provisions and take appropriate action against the brokers for failure to deliver securities at the time of settlement, which shall act as sufficient deterrent against failure to deliver.”

Important Considerations

Due to the 2020 crisis, the Indian Securities Regulators instituted a temporary ban on short-selling once again in March 2020. There were concerns about the impact of short selling on the stability of the financial markets. The ban was justified by the regulators saying that it would help the markets function in an efficient and right manner. The ban was in effect till October 2020.

Summing Up

Short Selling is risky for beginners in the stock market as it requires proper knowledge and experience. This strategy is a good way for investors to earn good money but some critics believe that it can cause problems in the financial market. The United States of America has a liberal approach towards short selling but India has put a ban on this strategy from time to time.

India put a pan on short selling for the 7-year period between 2001 and 2008 and then again in 2020. Naked Short Selling is still banned in India. The authorities believe that it will help provide a fair market for all the participants.

At Mahadevan Share Sense, we understand that trading can be a complex and daunting endeavor. That's why our mission is to empower traders with the knowledge, tools, and strategies they need to make informed decisions and maximize their profits. Our training programs cover a wide range of topics, including technical analysis, fundamental analysis, risk management, trading psychology, and more. We believe in a holistic approach to trading education, combining theoretical knowledge with practical exercises and real-time market simulations.
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