The Basics of Shorting Stock - The Balance

Shorting stock, also known as "short selling," involves the sale of stock that the seller does not own or has taken on loan from a broker. · Some traders do ... TableofContents Expand TableofContents WhySellShort? HowShortingStockWorks WhatAretheRisksofShortSelling? HowShortSellingDiffersFromInvesting FrequentlyAskedQuestions(FAQs) Assets&Markets Stocks Partof HowtoInvestinStocks Overview Stocks101 WhatAreStocks? MarketCapitalization StockSplits WhenaStockIsDelisted HowtoBuyStock TypesofStock KindsofStock BlueChip CommonStock Preferredvs.Common FAANGStocks PennyStocks DividendStocks PinkSheetStocks Risks&Alternatives MajorRiskstoConsider DealingWithLosses BewareofStockPromoters Bonds MutualFunds ETFs RealEstate Futures&Forex TradingStocks HowtoTrade HowtoSell Pros&Cons FindingLow-VolatilityStocks ShortingStock BestStockTradingApps BestPennyStockTradingApps TheBasicsofShortingStock ABeginner'sGuideforHowtoShortStocks By JoshuaKennon FullBio Twitter JoshuaKennonisanexpertoninvesting,assetsandmarkets,andretirementplanning.Heisthemanagingdirectorandco-founderofKennon-Green&Co.,anassetmanagementfirm. Learnaboutour editorialpolicies UpdatedOctober30,2021 Reviewedby CharlesPotters Reviewedby CharlesPotters FullBio LinkedIn Charlesisanationallyrecognizedcapitalmarketsspecialistandeducatorwithover30yearsofexperiencedevelopingin-depthtrainingprogramsforburgeoningfinancialprofessionals.CharleshastaughtatanumberofinstitutionsincludingGoldmanSachs,MorganStanley,SocieteGenerale,andmanymore. Learnaboutour FinancialReviewBoard  TheBalance Shortingstockisapopulartradingtechniqueforinvestorswithalotofexperience,includinghedgefundmanagers.Itcancreatelargeprofits.Butitalsoinvolvesthepotentialtolosealotofmoney. Shortingstock,alsoknownas"shortselling,"involvesthesaleofstockthatthesellerdoesnotownorhastakenonloanfromabroker.Investorswhoshortstockmustbewillingtotakeontheriskthattheirgamblemightnotwork. KeyTakeaways Shortstocktradesoccurbecausesellersbelieveastock'spriceisheadeddownward.Shortingstockinvolvessellingbatchesofstocktomakeaprofit,thenbuyingitbackcheaplywhenthepricegoesdown.Stockpricescanbevolatile,andyoucannotalwaysrepurchasesharesatalowerpricewheneveryouwant.Shortingastockissubjecttoitsownsetofrulesthataredifferentfromregularstockinvesting. WhySellShort? Usually,youwouldshortstockbecauseyoubelieveastock'spriceisheadeddownward.Theideaisthatifyousellthestocktoday,you'llbeabletobuyitbackatalowerpriceinthenearfuture. Ifthisstrategyworks,youcanmakeaprofitbypocketingthedifferencebetweenthepricewhenyousellandthepricewhenyoubuy.Youwillstillendupwiththesameamountofstockofthesamestockthatyouhadoriginally. Sometradersdoshortsellingpurelyforspeculation.Otherswanttohedge,orprotect,theirdownsideriskiftheyhavealongposition. Alongpositionmaybeowningsharesofthesameorarelatedstockoutright. HowShortingStockWorks Usually,whenyoushortstock,youaretradingsharesthatyoudonotown. Forexample,ifyouthinkthepriceofastockisovervalued,youmaydecidetoborrow10sharesofABCstockfromyourbroker.Ifyousellthemat$50each,youcanpocket$500incash. Atthatpoint,youhave$500incash,butyoualsoneedtobuyandreturnthe10sharesofstocktoyourbrokersoon.Ifthepriceofthestockgoesdownto$25pershare,youcanbuythe10sharesagainforonly$250. Yourtotalprofitwouldbe$250:the$500profityoumadeatfirst,minusthe$250youspendtobuythesharesback.Butifthestockgoesupabovethe$50price,you'lllosemoney.You'llhavetopayahigherpricetorepurchasethesharesandreturnthemtothebroker'saccount. Forexample,ifthestockweretogoto$250pershare,you'dhavetospend$2,500tobuybackthe10sharesyou'dowethebrokerage.You'dstillkeeptheoriginal$500,soyournetlosswouldbe$2,000. Calculatingprofitforashortsaleisslightlymorecomplex.Youwouldpayasmallcommissionforthetrade,whichwouldcomeoutofyourprofit.Dependingupontiming,youmightalsohavetopaydividendstothebuyerofyourshares. WhatAretheRisksofShortSelling? Whenyoushortastock,youexposeyourselftoalargefinancialrisk. OnefamousexampleoflosingmoneyduetoshortingastockistheNorthernPacificCornerof1901.SharesoftheNorthernPacificRailroadshotupto$1,000.SomeofthewealthiestmenintheUnitedStateswentbankruptastheytriedtorepurchasesharesandreturnthemtothelendersfromwhomtheyhadborrowedthem. Ifyouwanttosellstockshort,donotassumeyou'llalwaysbeabletorepurchaseitwheneveryouwant,atapriceyouwant.Stockpricescanbevolatile. Wheninvesting,youshouldneverassumethatforastocktogofrompriceAtopriceC,ithastogothroughpriceB.Themarketforagivenstockhastoexist.Youmayenduplosingsignificantmoneyif: Nooneissellingthestock.Therearetoomanybuyersbecauseothershortsellersaretryingtocloseouttheirpositionsaswell. HowIsShortSellingDifferentFromRegularInvesting? Shortingastockhasitsownsetofrules,whicharedifferentfromregularstockinvesting,includingaruledesignedtorestrictshortsellingfromfurtherdrivingdownthepriceofastockthathasdroppedmorethan10%inoneday,comparedtothepreviousday'sclosingprice. Intheory,theriskoflossesonashortsaleisinfinite.Astockpricecouldcontinuetorisewithnolimit.Theshortsellingtacticisbestusedbyseasonedtraderswhoknowandunderstandtherisks. FrequentlyAskedQuestions(FAQs) HowlongcanIshortastock? Intheory,youcanshortastockaslongasyouwant.Inpractice,shortingastockinvolvesborrowingstocksfromyourbroker,andyourbrokerwilllikelychargefeesuntilyousettleyourdebt.Therefore,youcanshortastockaslongasyoucanaffordthecostsofborrowing. Whatistheoppositeofshortingastock? Theoppositeofshortingastockis"goinglong."That'showtradersrefertoopeningapositionwithabuyorder,asopposedtoasellorder.Inotherwords,theoppositeofshortingastockisbuyingit. Doesshortingastockbringthepricedown? Anindividualisunlikelytoimpactthepricewithasingleshortsaleorder.However,allsellingputsdownwardpressureonstockprices,whetherit'sashortsellerorabuy-and-holdinvestorfinallydecidingtosellafterdecadesofholdingthestock.Ifenoughpeoplesellatonce,regardlessofwhetherit'sshortsellingornot,itcandragdownthestockprice. Howdoyouprofitfromafallingcompanywithoutshortingthestock? Twoofthemostcommonwaystoprofitfromastock'sdeclinewithoutshortingareoptionsandinverseETFs.Buyingaputoptiongivesyoutherighttosellastockatagiven"strikeprice,"sothebuyerhopesthestockgoesdownandtheycanmakemoremoneybysellingatthestrikeprice.InverseETFscontainswapsandcontractsthateffectivelyreplicateashortposition.Forexample,SQQQisaninverseETFthatmovesintheoppositedirectionofQQQ.IfyoubelievethepriceofQQQshareswillgodown,thenshortingQQQ,buyingaputoptiononQQQ,andbuyingsharesinSQQQwillallallowyoutoprofitfromamovedown. ArticleSources U.S.SecuritiesandExchangeCommission."InvestorBulletin:AnIntroductiontoShortSales."AccessedMay12,2021. ProjectMUSE."Harrimanvs.Hill:WallStreet’sGreatRailroadWarbyLarryHaeg(Review)."AccessedMay12,2021. Fidelity."AboutShortSelling."AccessedMay27,2020. U.S.SecuritiesandExchangeCommission."ShortSaleRestrictions."AccessedMay12,2021. 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