Can anyone explain Short selling and short covering? It's really confusing me!

General
1

I read a article in ET today. Link - http://epaperbeta.timesofindia.com/Article.aspx?eid=31818&articlexml=Fundamentals-US-Fed-Tone-Keep-D-St-in-20122014006005

A quote says ''Indian markets rose for the second straight day on Friday , mirroring gains in global equities as traders ''covered their short positions'' after the Federal Reserve's comment that it's not in hurry to withdraw stimulus-revived sentiment''

What does it mean?

2

Short selling means selling something that you do not own, i.e you sell it now and deliver that thing later. Why would you do this? Because you believe that price for that item will go down in future. So you sell it at current higher price to buy it later at lower price.

Short covering means buying the item that you short sell earlier to a person to deliver it to him. Example I sold a car (which I do not own currently) to Mr.A in the morning with the promise that I will deliver it in the evening. Now when I sold the car that would be called short selling and when I buy the car (say in the afternoon) that would be called short covering. It is necessary because I have to deliver that car in the evening to Mr.A

Now coming to the point that you asked, when market sentiments were down, traders started short selling because they believed that markets would go down more, however after the Fed’s announcement the scenario changed and the traders had to short cover their positions to prevent their trades going against them. In simple words it means that when markets start falling you and other traders start selling more and more in the belief that you will buy back later at a very reduced price. So when the short-covering starts i.e when you and other traders like you start buying to deliver the shares/futures you short sold earlier, the markets start recovering. This is what is going on with Indian markets currently.

2 Likes
3

Traders trade different products on exchanges like Equity, Futures, Options etc. In each of these products, their trades can be of two types: BUY side and SELL side. 

Product BUY side SELL side
Equity Buy with cash (a)Sell the securities in demat.
(b)Sell the securities not in demat, but with cash margin as INTRADAY trade.
Futures Buy with cash margin (a)Sell the bought Futures contract.
(b)Sell the Futures with cash margin.
Options Buy with cash (a)Sell the bought Options contract.
(b)Sell the Options contract with cash margin.

In the table, all the trades marked as (b) are called Short positions(Short selling).

'Traders covered their short positions'  means they have closed those Short positions ((b)) and as a result the Indian market rose.

4

Good one Chirag! Very lucid

5

Thanks AastroGuru

6

Thanks chirag!