By DK Aggarwal
Retail investors are often seen getting trapped when there is a short selling in the market. Recently, the domestic market witnessed wild volatility with a negative bias due to a rise in Covid-19 cases, as it raised uncertainty about the global economy.
The spread of Covid-19 has shaken up financial markets in response to tough government actions to combat the pandemic and to support their respective economies. In India, as stocks saw sharp falls in the wake of the Covid-19 outbreak, Sebi slapped a ban on short selling in an attempt to stabilise the market and maintain investor confidence. It also increased margin requirements.
Now, the question is: will short selling come back flooding when Sebi lifts the curbs and trap retail investors.
First, we need to understand that the prevailing uncertainty is the result of Covid-19. Investors are concerned about the accelerated spread of the infection across the world and the potential economic fallout of the same. A vaccine, or at least an effective therapy, remains the No. 1 focus for the market to move higher. The market will move hurriedly northward once we have a medical breakthrough in terms of a vaccine or cures.
History shows while economies may take several months to bottom out, markets bottom out early, as they are always forward looking. In an adverse situation, if there is no breakthrough and if economic growth plunges, the short selling ban may or may not bring temporary relief to the market. However as volumes evaporate, the market would become illiquid and choppy and banning short selling can be of no help. Evidence from the past indicates that a ban on short-selling cannot prevent a fall in stocks; at best it can change opinion or sentiment.
Sebi’s endeavour to curb ‘abnormally high’ volatility amid the coronavirus pandemic has reduced volumes in the market. The Indian regulator was not alone in banning short selling; even regulators in many global markets such as the Europe, China and South Korea took measures to prohibit short selling.
Sebi is unlikely to lift the ban on short selling until and unless the whole situation comes under control. In India, the practice of borrowing shares and selling them is virtually non-existent. Short-selling is done through the futures and options segment.
Mutual funds, foreign players and proprietors are the usual short sellers in the bearish market. Once sentiment improves, investors will participate in a rally rather going for shorts. When everything goes in the right direction, the market would focus on moving up, and hence, there is no question of retail investors getting trapped when the ban gets lifted.
DK Aggarwal is Chairman and MD, SMC Investments and Advisors.