What is short selling, from which Hindenburg Research earns money? This method of earning is dangerous for the market

After the controversial report of Hindenburg against Adani Group and now against SEBI chief, one word is being discussed everywhere. That word is short selling. Actually, American firm Hindenburg Research issues controversial reports against a listed company because it earns huge profits from it. It first shorts the shares of the target company and then its report against the target company comes out.

Let us know what is this short selling of shares and how do investors like Hindenburg Research earn from it? What kind of earnings are made from short selling, for which companies like Hindenburg Research do not hesitate to throw mud on a listed company? Also, let us know why the method of earning from short selling is considered overall dangerous for the market?

The name of short selling came into the headlines last year

Short selling is not a new thing. Although many people in India heard the name of short selling for the first time last year, when Hindenburg Research came out with a controversial report against the Adani Group. Hindenburg Research made several serious allegations against the Adani Group in the report released on 24 January 2023. The allegations included wrongly inflating the price of shares, creating a web of shell companies and using a network of anonymous foreign funds to manipulate money, etc.

Adani’s shares had suffered so much loss

After that report of Hindenburg, the shares of Adani Group started falling down. The decline that started from January 24 continued for the next one month and during that time many shares of Adani Group kept falling prey to lower circuit every day. The prices of most of the shares of the group were halved and they fell by up to 83 percent in just one and a half months. Due to this decline, the market cap of Adani Group companies fell by more than $ 150 billion. It can also be said that due to the Hindenburg report against the Adani Group, investors of Adani shares lost more than $ 150 billion.

Hindenburg Report’s connection to short selling

On one hand, a large number of investors went bankrupt, while on the other, many made huge profits. Especially, American short seller firm Hindenburg Research earned millions of dollars. A Bloomberg report states that Hindenburg earned more than $4 million last year by shorting Adani’s shares. Now, the new report released by Hindenburg has a direct connection with the huge earnings made last year by shorting the shares. Regarding the same earnings, market regulator SEBI had issued a show cause notice to Hindenburg. Hindenburg did not give an official reply to that notice, but in return, it attacked SEBI. In the latest report, Hindenburg has accused SEBI chief Madhabi Puri Buch of having financial connections with the Adani Group, which has been denied by both the SEBI chief and the Adani Group.

This is how shares are shorted

Big investors in the stock market earn money in both rising and falling price situations. Talking about short selling, it is a way of earning money by lowering the price in the stock market. Let’s understand it with an example. The short seller first shorts the target share. Suppose a share is currently worth Rs 500, but the short seller feels that the share can fall to Rs 400 in a week. Now the short seller borrows 100 shares of that company from the broker and sells them. After a week the share falls to Rs 400. Now he buys 100 shares from the open market and returns the shares borrowed from the broker.

This is how investors earn from short selling

In this case, the short seller earned Rs 100 on each share of the target company. The shares which he had borrowed at the rate of Rs 500, he got them back for just Rs 400. That is, a profit of Rs 100 on each share. In this way, he made a profit of Rs 10,000 by shorting only 100 shares in a week. In the case of Adani Group, Hindenburg first took a short position on the shares and then released a controversial report to bring down the prices. In other words, it can also be said that it deliberately brought down the price of Adani shares for its earnings.

Huge losses in pursuit of minor gains

The profit made by shorting stocks is not considered good for the market in a broader perspective. The reason for this is that the loss of other investors is many times more than the profit made by the short seller. You can clearly see this figure in the case of Adani. Hindenburg earned about 4 million dollars, while the rest of Adani’s investors lost more than 150 billion dollars. That is, the market suffered a loss of more than 37 thousand times the profit made by Hindenburg.

Why is short selling bad for the health of the market?

In such a strategy, when investors lose money on a large scale, they get disillusioned with the market. After suffering a huge loss, many investors are unable to turn to the market again. This is the biggest risk for the growth of any market that people start fearing to invest in it. In the case of Adani, even though the group’s shares almost recovered the losses caused by the Hindenburg report, it took a year. In many cases, the shorted shares are never able to achieve the old level.

Also read: Experts’ opinion on Hindenburg report – an attempt to throw mud, the allegations hold no merit