Shorting how does it work

Visit About Us to find out more. Skip header Skip to main content. Personal Banking. Contact Us Language. Written by The Content Team Published on March 29, Share this article on Facebook opens new window Tweet this article on Twitter opens new window Share this article on LinkedIn opens new window Share this article on email opens new window.

Thank You! Please try again at a later time. How it works Let's say an investor named Sarah has been researching XYZ Company for months and she believes the stock price is going to fall. She knows she may have to add funds to her margin account to cover market fluctuations see Mark to Market below. Find out more in Understanding Margin Accounts. Sarah waits At this point, there are three possible outcomes.

Let's take a closer look at the three possible outcomes: Stock Price Rises. What Are the Costs? With short selling, the following costs may apply: Trading fees. You are buying and selling stock, so standard brokerage commissions apply. Dividends 1. If the stock you've shorted pays a dividend during the time you hold the short position, you are responsible for paying that dividend amount to the brokerage you borrowed the shares from.

Mark to Market. Remember, with short selling you want the price to fall. When an investor buys a stock or goes long , they stand to lose only the money that they have invested. However, when investors short sell, they can theoretically lose an infinite amount of money because a stock's price can keep rising forever. Another risk faced by short sellers is that of a " short squeeze ," in which a stock with a large short interest i.

This triggers a steeper price ascent in the stock as more and more short sellers buy back the stock to close out their short positions and cap their losses.

In January , followers of a popular Reddit page called Wall Street Bets banded together to cause a massive short squeeze in stocks of struggling companies with very high short interest, such as video game retailer GameStop.

This caused the company's share prices to soar fold and sixfold in January alone. Short selling can generally only be undertaken in a margin account , a type of account by which brokerages lend funds to investors and traders for trading securities. Therefore, the short seller has to monitor the margin account closely to ensure that the account always has sufficient capital or margin to maintain the short position. If the stock that the trader has sold short suddenly spikes in price for example, if the company announces in its quarterly report that earnings have exceeded expectations , the trader will have to pump additional funds into the margin account right away, or else the brokerage may forcibly close out the short position and saddle the trader with the loss.

If an investor shorts a stock, there is technically no limit to the amount they could lose because the stock can continue to go up in value indefinitely.

In some cases, investors could even end up owing their brokerage money. Short selling can serve the purposes of speculation or hedging. Speculators use short selling to capitalize on a potential decline in a specific security or across the market as a whole. Hedgers use the strategy to protect gains or mitigate losses in a security or portfolio.

Notably, institutional investors and savvy individuals frequently engage in short-selling strategies for both speculation and hedging simultaneously.

Hedge funds are among the most active short-sellers and often use short positions in select stocks or sectors to hedge their long positions in other stocks.

Though short selling does present investors with an opportunity to make profits in a declining or neutral market, only sophisticated investors and advanced traders should attempt it due to its risk of infinite losses. Short selling is not a strategy many investors use, largely because the expectation is that stocks will rise in value over time. In the long run, the stock market tends to go up, although it is occasionally punctuated by bear markets in which stocks tumble significantly.

For the typical investor with a long-term investment horizon, buying stocks is a less risky proposition than short selling. Short selling may only make sense in certain situations, such as in a protracted bear market or if a company is experiencing financial difficulties. That said, only advanced investors who have a high tolerance for risk and understand the risks associated with short selling should attempt it.

Trading commissions are not the only expense involved when short selling. Measure content performance. Develop and improve products. List of Partners vendors. Part of. How to Invest in Stocks Overview Stocks Types of Stock. Trading Stocks. Table of Contents Expand.

Table of Contents. Why Sell Short? How Shorting Stock Works. What Are the Risks of Short Selling? Learn about our editorial policies. Reviewed by Charles Potters. Article Reviewed October 30, Charles is a nationally recognized capital markets specialist and educator with over 30 years of experience developing in-depth training programs for burgeoning financial professionals.

Charles has taught at a number of institutions including Goldman Sachs, Morgan Stanley, Societe Generale, and many more. Learn about our Financial Review Board. Key Takeaways Short stock trades occur because sellers believe a stock's price is headed downward. Shorting stock involves selling batches of stock to make a profit, then buying it back cheaply when the price goes down. But he received little sympathy from other investors, as you can read on his GoFundMe page. This is one way for individual investors to short stocks of companies that Lamensdorf and co-manager John Del Vecchio think are headed lower, based on analyses of their financial reports.

When a major investor places a short, it can be helpful to other investors. For example, Citron Research published a report on Oct. Then on Oct. Philidor, in turn, said on Nov.