Short selling is a method of stock trading that allows investors to profit from an investment vehicle that is going down in value and that they do not own. To be able to short sell a stock, a trader needs to borrow the stock from someone who owns it (though the brokerage or investment firm) and sells it, hoping to repay the loan of the stock by buying the shares for a lower price in the future. Said another way, if the price goes down as the trader hope, they buy back the same asset, now at a lower price and pocket the difference as profit. While short selling comes with potentials risks, it can be a profitable way to trade.
How does short selling work?
Also known as shorting a stock, this approach to stock trading may seem counterintuitive, especially to typical long-term investors. Since stocks are known to go up over time (though of course there are corrections and small hiccups), many traders with a long horizon, buy assets with the expectation that they will hold onto them for a long time. It may be a good or not so good financial investment decision, as major corrections and timing issues, as well as the quality of the asset they invest in and potential political events, influence the “success” of the investment.
But shorting a stock might be a wise move for traders with a shorter trading perspective. How do you borrow a stock to short sell? This is how short selling works:
- Find an opportunity where you feel a stock will go down in value. Likewise, some traders may decide to short sell a stock if you are hedging against a long position in the same asset, sector or a related security.
- Borrow the asset from someone who already owns it. This generally can be arranged with your broker, who will also enable you to borrow money to cover the position and then arrange to borrow the stock on your behalf. You will be charged interest for the loan and may be responsible for other fees involved in short selling stocks.
- Be sure you have an account that will let you borrow the money to hold the asset.
- Be prepared for potential losses as well as potential gains. Remember if the asset increases in value, you will be responsible
- When the stock value decreases, you sell your position, making a profit from your short sale.
Is shorting stocks a good idea?
Short selling stocks can be useful for traders who have a particular trading strategy or have identified a certain security they believe will go down in price. Some people look for companies they think are poised to go down in value, perhaps the shares of companies that are mismanaged or are going through a rough spot, or recently had a large upswing in price. Many brokerage investment firms assist traders who want to short sell, finding the shares to borrow, loaning the money needed to borrow the stock, and arranging the entire procedure.