Short Selling
What Is Short Selling?
Short selling is an investment strategy where an investor borrows shares of a security and sells them with the expectation that the price will decline. The investor then buys the shares back later at a lower price to return them to the lender.
The difference between the selling price and the repurchase price represents the potential profit.
Why It Matters
Short selling allows investors to potentially profit from declining stock prices. It can also help hedge against losses in other investments.
However, short selling carries significant risk because stock prices can theoretically rise without limit.
How Short Selling Works
The process typically involves:
- borrowing shares from a brokerage firm
- selling the shares in the market
- waiting for the price to fall
- buying the shares back at a lower price
- returning the shares to the lender
The investor profits if the repurchase price is lower than the original sale price.
Example
An investor sells borrowed shares at $100 per share. The price later drops to $70, and the investor buys the shares back, earning a $30 profit per share.
Short Selling vs Buying Long
- Short selling profits from falling prices.
- Buying long profits from rising prices.
FAQs About Short Selling
Is short selling risky?
Yes. Potential losses can be unlimited if the stock price rises significantly.
Do investors need special accounts for short selling?
Yes. Short selling typically requires a margin account.
Why do investors short stocks?
To speculate on price declines or hedge other investments.
Related Terms
