Short Selling: Pros, Cons, and Examples

If the seller predicts the price moves correctly, they can make a positive return on investment, primarily if they use margin to initiate the trade. Using margin provides leverage, which means the trader does not need to put up much of their capital as an initial investment. If done carefully, short selling can be an inexpensive hedge, a counterbalance to other portfolio holdings. Yes, most exchange-traded funds (ETFs) can be shorted like regular stocks.

  1. For example, you would lose $175 per share if you had a short position in Meta (having borrowed the stock at $200 per share), and the price rose to $375 before you got out.
  2. For example, Seth Klarman, a hedge fund billionaire who runs Baupost, an investment group, says that short selling is necessary to counter bull markets.
  3. Most hedge funds try to hedge market risk by selling short stocks or sectors that they consider overvalued.
  4. Losses are theoretically infinite since there’s no limit to how high a share price can go.
  5. The biggest risk involved with short selling is that if the stock price rises dramatically, you might have difficulty covering the losses involved.

The higher the strike price and the longer the time until the expiration date, the higher the option premium. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.

Short selling is a trading strategy where investors speculate on a stock’s decline. Short sellers bet on, and profit from a drop in a security’s price. Traders use short selling as speculation, and investors or portfolio managers may use it as a hedge against the downside risk of a long position. Short selling a stock is when a trader borrows shares from a broker and immediately sells them with the expectation that the share price will fall shortly after. If it does, the trader can buy the shares back at the lower price, return them to the broker, and keep the difference, minus any loan interest, as profit.

Lower Saxony and Porsche, who together owned more than 90 percent of the company, would not be willing to sell their positions. Short squeezes occur when a trader purchases a large block of shares to finish a short position. The purchase could result in artificial demand for a company’s shares and result in a temporary price bump for the security. Short selling, also known as shorting a stock, is a trading technique in which a trader attempts to generate profits by predicting a stock’s price decline. The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.

What is the margin requirement for Short Selling?

If a stock’s price goes up instead of down, the short seller will lose money—and that doesn’t even include the fees to borrow shares that are part of this trading strategy. Short selling has arguably gained more respectability in recent years with the involvement of hedge funds, quant funds, and other institutional investors on the short side. The eruption of two global bear markets within the first decade of this millennium has also increased the willingness of investors to learn about short selling as a tool for hedging portfolio risk.

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The speculator borrows shares of Meta and sells them at the current market price of $200. A few months later, as anticipated, the stock falls to $125 per share. The speculator then buys back the same number of shares at this lower price to return them to the lender, profiting from the difference of $75 per share. Short selling is, nonetheless, a relatively advanced strategy best suited for sophisticated investors or traders who are familiar with the risks of shorting and the regulations involved. The average investor may be better served by using put options to hedge downside risk or to speculate on a decline because of the limited risk involved.

If that’s the case, investors can potentially make money when the value of a stock goes down by using a strategy called short selling. Also known as shorting a stock, short selling is designed to give you a profit if the share price of the stock you choose to short goes down — but can also lose money for you if the stock price goes up. For example, a speculator believes that Meta, trading at $200 per share, is overvalued and will likely see its stock price decline in the coming months.

In recent times, active investors and short sellers have contended that the growth of passive investing products, such as ETFs, has contributed to a decline in short selling’s popularity. When you sell the stock short, you’ll receive $10,000 in cash convert us dollars to swedish kronor proceeds, less whatever your broker charges you as a commission. That money will be credited to your account in the same manner as any other stock sale, but you’ll also have a debt obligation to repay the borrowed shares at some time in the future.

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At this point, you have to deposit more funds or securities into the margin account. Your broker may require you to sell securities at market price to meet the margin call if you don’t deposit the necessary funds. The regulation was implemented in 2005 over concerns that failures to deliver (FTDs) stocks in short sales were increasing. This is believed to occur more often when there is naked short selling in the market. Short selling allows investors and traders to make money from a down market. Those with a bearish view can borrow shares on margin and sell them in the market, hoping to repurchase them at some point in the future at a lower price.

That can have the effect of keeping a stock at a lower price than it would have if only cheerleaders were on the sideline. Given the market’s long-term upward bias, many investors find it hard to short stocks and achieve consistent, profitable results. What’s more, the risk — especially if you’re not sure what you’re doing — is much higher than a buy-and-hold strategy. The biggest risk of short selling is the potential for unlimited losses.

This buying activity then drives the stock price up still further. This typically happens with stocks that have high short interest, meaning a large part of the stock’s available shares are sold short. Short selling is an advanced trading strategy that flips the conventional idea of investing on its head. Most stock market investing is known as “going long”—or buying a stock to sell it later at a higher price. If traders short a stock, they are “going short,” or betting that the stock’s price will decline. Because in a short sale, shares are sold on margin, relatively small rises in the price can lead to even more significant losses.

Bringing greater transparency to short sales became a priority following the 2021 “meme stock” phenomenon. If the stock that was sold short suddenly spikes in price, the trader will have to pump more funds quickly into the margin account. This might happen if the company whose stock has been shorted announces earnings that exceed expectations.

The SEC warns that most traders lose money in their first months of trading, and many never turn a profit. There are examples of short sellers who have been proved right in cautioning about corporate wrongdoing or impending doom. Essentially, a put option gives you the right — but not the obligation — to sell a stock at a predetermined price (known as the strike price) at any time before the option contract expires. Short-selling can be profitable when you make the right call, but it carries greater risks than what ordinary stock investors experience. Short-selling allows investors to profit from stocks or other securities when they go down in value. Short selling acts as a reality check that can eventually limit the rise of stocks being bid up to ridiculous levels during times of excessive exuberance.

Short selling, also known as shorting a stock, is a trading technique in which a trader attempts to generate profits by predicting a stock’s price decline. Pension funds and large institutional investors invest in stocks for the long-term and are averse to short sellers. Short selling was also blamed for the 1929 and 1987 stock market crashes. During the financial crisis, the SEC imposed an emergency ban on short selling in September 2008. Prominent defenders of short selling include activist investors and firms. Joe shorts the stock, betting that the company’s shares will decline to $50.

Related investing topics

Some traders might place the buy stop just above a moving average, or above the most recent high price the stock achieved. This would represent a possible change in the behavior of the price action and the short seller might want to move on quickly. Shorting a stock enables traders to try and capitalize on declining markets. This video walks you through an example to demonstrate the basics behind short selling and how to mitigate the potential risks.