Read This Story Before Shorting a Stock

It’s possible to make money in the market no matter which way it moves—up, down, or sideways. For new investors, betting on a move down may sound strange. The more traditional way to profit in financial markets is a buy-and-hold strategy: purchasing a security, holding it, selling it on a later date for a higher price.

However, of course, not all assets climb higher. So what do investors do when they’re reasonably certain that a particular stock or industry will be trending lower? Shorting a stock, also known as short selling, is one way to potentially profit from a downward move. This strategy is popular among savvy, risk-tolerant investors who may have a knack for market research and predicting trends.

What Is Shorting a Stock?

Margin accounts are brokerage accounts that are required by the federal government to regulate broker lending to investors. To short a stock, an individual first borrows shares from a brokerage firm that currently holds a position in the stock.

Then, the borrower sells the borrowed shares on the open market to another investor, with the plan that when the stock price drops, the borrower will buy back the same number of shares they borrowed (or more, if they choose), in order to return them to the brokerage firm.

If the share price of the stock declines, the borrower can buy the same shares for less money and pocket the difference. But if the share price increases, the borrower will lose money. They would have to buy the same shares for a higher price.

Example of Shorting a Stock

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Read This Story Before Shorting a Stock

TIM THOMAS

What Is Shorting a Stock?

Shorting a stock is a way for investors to make a bet that the future share price of a particular stock will be lower than its current price. There are multiple ways this can be accomplished. For now, we’ll focus on margin trading.

Margin accounts are brokerage accounts that are required by the federal government to regulate broker lending to investors. To short a stock, an individual first borrows shares from a brokerage firm that currently holds a position in the stock.

Then, the borrower sells the borrowed shares on the open market to another investor, with the plan that when the stock price drops, the borrower will buy back the same number of shares they borrowed (or more, if they choose), in order to return them to the brokerage firm.

If the share price of the stock declines, the borrower can buy the same shares for less money and pocket the difference. But if the share price increases, the borrower will lose money. They would have to buy the same shares for a higher price.

Example of Shorting a Stock

Here’s a hypothetical case. Let’s say an investor found a company that they think is overvalued. They borrow 100 shares of stock in company A at a price of $10 per share for a total of $1,000 (plus any applicable brokerage fees).n scenari

Example of Shorting a Stock

Great! Now the investor can buy back 100 shares at a price of $9 for only $900, and the leftover $100 is the profit. In scenario B, the investor misses the mark, and the price rises to $11 per share. Now they have to buy back 100 shares at a price of $11 for a total of $1,100, for a loss of $100.

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