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explain shorting a stock

In addition, you’ll have to pay a “cost of borrow” for the stock, which may be a few percent a year on your total loan, though it could be much higher. That’s a fee paid to the broker for the service of finding stock to sell short. Short selling is a way to invest so that you can attempt to profit when the price of a security — such as a stock — declines. It’s considered an advanced strategy that is probably best left to experienced investors and professional traders. One may also take a short position in a currency using futures or options; the preceding method is used to bet on the spot price, which is more directly analogous to selling a stock short.

NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances. Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance.

Shorting alternatives: other ways to profit from declining prices

There are several trading styles, methods, and reasons investors choose to short stocks. Some investors view shorting stocks as a way to hedge their portfolios against market declines. Hedging is a risk management technique used to offset potential losses in other investments. It involves taking a position in an asset inversely correlated to the investor’s other holdings. For example, if the investor is long on stocks, they might consider shorting a stock index ETF to hedge their position. But there is also naked short selling — the illegal practice of short selling shares that the investor never actually obtained.

This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, explain shorting a stock including the possible loss of capital. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals.

How do I short sell a stock?

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Market professionals call this phase of the investment cycle “priced for perfection,” since investors will invariably be disappointed at some point when their lofty expectations are not met. Rather than rushing in on the short side, experienced short sellers may wait until the market or sector rolls over and commences its downward phase. Using the scenario above, let’s now suppose the trader did not close out the short position at $40 but decided to leave it open to capitalize on a further price decline. However, a competitor swoops in to acquire the company with a takeover offer of $65 per share, and the stock soars. For instance, if you own call options (which are long positions), you may want to sell short against that position to lock in profits. Or, if you want to limit downside losses without actually exiting a long stock position, you can sell short in a stock that is closely related to or highly correlated with it.

What Are the Risks of Short Selling?

When you’re ready to exit the trade, use a “buy to cover” order to buy and return the borrowed shares. In most cases, your broker will require you to have available funds equal to 50% of the value of the shorting trade. In other words, if you short 10 shares of a $200 stock, you need to have $1,000 available as margin in your brokerage account. So, the idea behind buying a put option is similar to shorting, although the most you can possibly lose is what you pay for the put option. Now, there’s more to trading options than I can explain here, so do your homework if this is a strategy that sounds appealing to you.

explain shorting a stock

But if you do decide to short stocks, make sure you fully understand the risks and have a clear exit plan for getting out of the short, if the stock price starts to rise against you. If the stock price falls after the shares are sold, the short seller can buy back the shares at the lower price and return them to the person they borrowed them from, keeping the difference in price as profit. “Selling short against the box” consists of holding a long position on which the shares have already risen, whereupon one then enters a short sell order for an equal number of shares.

Commitments of Traders

The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. For example, if the stock were to go to $250 per share, you’d have to spend $2,500 to buy back the 10 shares you’d owe the brokerage. You’d still keep the original $500, so your net loss would be $2,000. Usually, when you short stock, you are trading shares that you do not own. If this strategy works, you can make a profit by pocketing the difference between the price when you sell and the price when you buy.

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