What Is Short Selling? A Simplified Guide on How To Short a Stock

Short selling is an advanced trading strategy investors use when they speculate whether the price of a stock is going down.

How it works: Investors borrow a share and sell it, with the hopes of buying it back later at a lower price. It’s also a strategy that’s been making headlines in recent months.

If you’ve been keeping up with the stock market news, you might’ve heard about short sellers losing millions of dollars due to the soaring prices of stocks, such as AMC and GameStop Corp.

Whether you’re an investor yourself or interested in learning about investing, you’re in the right place to discover just what is short selling, including how to short sell stocks as well as the risks and benefits of short selling

Short Selling Explained

What does it mean to short a stock? Short selling stocks is an advanced trading strategy used either to hedge or speculate the anticipated decline in stock price.

If the stock price goes down, it will result in a gain. If it goes up, it will result in a loss.

It’s essentially the opposite of long position investing. Long position investors own shares of stocks that they bought at a lower price and keep ownership of the stock expecting the prices to rise in order to make a profit when the stock is sold.

In contrast, short position investors borrow the shares from a broker and sell them at a higher price hoping the stock price will fall, so they can buy it back at the lower price and make a profit.

However, shorting stocks theoretically has an unlimited risk of loss since there is no cap on the price of a stock.

In order to short the stock market, a trader must have a margin account, which is a type of brokerage account. In this arrangement, the broker lends cash to the investor to purchase stocks, which comes with an interest rate.

The margin account also has a regulated minimum value, and if it falls below the maintenance margin, the investor is required to either add more funds to the account or sell their positions.

Why Short Sell Stocks?

Shorting stocks is common in the stock market, and is usually done by hedge funds and professional investors. Two of the main reasons for stocks being shorted are to speculate and to hedge.

  1. Hedge:

The majority of investors who practice shorting will do so as a way to hedge risk of stock ownership, commonly referred to as long a stock. If the market goes down the short position will protect the long, and If the market goes up the long position will protect the short.

For hedging to work, both long and short positions must be highly correlated.

2. Speculate:

A speculator is an investor who embraces additional risk and resultant reward.

A short selling example of this was in 1992, when George Soros risked a $10 billion short position in the British pound and made an estimated $1 billion on the trade in a matter of months.

How To Short a Stock

If you’re wondering how to short sell stocks, keep in mind that it can be a high-risk investment and should only be done by experienced investors and traders.

Here is the process of shorting stocks explained in five steps:

  1. The first thing needed to start short selling stocks is to check the margin requirements on the stock.
  2. After meeting the margin requirements, the broker borrows the shares, which comes with an interest rate on the outstanding debt.
  3. Once the shares are borrowed, investors will then sell shares at the current market price, with the hopes that the price will go down.
  4. If the share prices go down, the investor will then buy those shares back at the lower price.
  5. Since the shares were borrowed, the short seller will then return those shares to the lender and keep the difference as a profit.

Pros and Cons of Short Selling Stocks

In the big picture, shorted stocks seem simple. However, there are some advantages and disadvantages:

FAQs About Short Selling

Here are some commonly asked questions traders may have when learning about short selling:

Sources: Forbes

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