Short Sale

Loading the player...

What is a 'Short Sale'

A short sale is a market transaction in which an investor sells borrowed securities in anticipation of a price decline and is required to return an equal number of shares at some point in the future.

The payoff to selling short is the opposite of a long position. A short seller will make money if the stock goes down in price, while a long position makes money when the stock goes up. The profit that the investor receives is equal to the value of the sold borrowed shares less the cost of repurchasing the borrowed shares.

BREAKING DOWN 'Short Sale'

Suppose 1,000 shares are short sold by an investor at $25 apiece and $25,000 is then put into that investor's account. Let's say the shares fall to $20 and the investor closes out the position. To close out the position, the investor will need to purchase 1,000 shares at $20 each ($20,000). The investor captures the difference between the amount that he or she receives from the short sale and the amount that was paid to close the position, or $5,000.

There are also margin rule requirements for a short sale in which 150% of the value of the shares shorted needs to be initially held in the account. Therefore, if the value is $25,000, the initial margin requirement is $37,500 (which includes the $25,000 of proceeds from the short sale). This prevents the proceeds from the sale from being used to purchase other shares before the borrowed shares are returned.

Short selling is an advanced trading strategy with many unique risks and pitfalls. Novice investors are advised to avoid short sales because this strategy includes unlimited losses. A share price can only fall to zero, but there is no limit to the amount it can rise.

RELATED TERMS
  1. Buy To Cover

    A buy order made on a stock or other listed security that closes ...
  2. Short (or Short Position)

    A short position is the sale of a borrowed security, commodity ...
  3. Bear Position

    Alternate term for a short position in a financial security. ...
  4. Weak Shorts

    Traders or investors who hold a short position in a stock or ...
  5. Net Short

    A condition in which an investor has more short positions than ...
  6. Credit Balance

    In a margin account, the amount of funds deposited in the customer's ...
Related Articles
  1. Active Trading Fundamentals

    Short Selling Risk Can Be Similar To Buying Long

    If more people understood short selling, it would invoke less fear, which could lead to a more balanced market.
  2. Active Trading Fundamentals

    Short Selling: The Risks

    Now that we've introduced short selling, let's make one thing clear: shorting is risky. Actually, we'll rephrase that. Shorting is very, very risky. It's not unlike running with ...
  3. Active Trading Fundamentals

    Short Selling: Why Short?

    Generally, the two main reasons to short are to either speculate or to hedge. When you speculate, you are watching for fluctuations in the market in order to quickly make a big profit off of ...
  4. Trading Strategies

    Simulator How-To Guide: Short Selling

    Most small investors cringe at a bear market when it seems like all stocks are in a steady decline. There is, however, a technique to profit from falling stock prices called "selling short", ...
  5. Active Trading Fundamentals

    Short Interest: What It Tells Us

    This figure can be a real eye-opener about the market sentiment surrounding a given stock.
  6. Term

    Understanding Short Covering

    Short covering is buying back borrowed securities to close an open short position.
  7. Investing Basics

    Why You Should Never Short a Stock

    Short selling a stock means you are betting on the stock decreasing in price. Before taking on this investment, you should fully understand the risks
  8. Active Trading Fundamentals

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
  9. Trading Strategies

    Short Interest: What It Tells Us

    A stock’s short interest is the total number of shares that investors have sold short but have yet to close.
  10. Investing

    Why I'm Going Long On One Of The Most Hated Stocks In The Market

    Short selling is a hotly debated topic among investors, especially after a strong bull market when valuations start looking a little stretched. Some investors have no problem with borrowing shares ...
RELATED FAQS
  1. What's the difference between a long and short position in the market?

    Understand long and short positions for stocks and option contracts; combine long and short positions for added leverage ... Read Answer >>
  2. When short selling, how long should you hold on to a short?

    Explore the reasons for short selling and the various factors that influence how long an investor may wish to maintain a ... Read Answer >>
  3. If I short sell $5,000 worth of stock and the stock becomes worthless, I have made ...

    The simple answer is that the maximum return of any short sale investment is in fact 100%. However, the concepts underlying ... Read Answer >>
  4. Please explain what a short seller is on the hook for when he or she shorts a stock ...

    Short selling is hard enough to get your head around without getting into all the particulars. If you have a basic understanding ... Read Answer >>
  5. How is it possible to trade on a stock you don't own, as is done in short selling?

    Understand how the process of short selling allows a person to sell a stock he or she doesn't technically own by borrowing ... Read Answer >>
  6. Why do you need a margin account to short sell stocks?

    The reason that margin accounts and only margin accounts can be used to short sell stocks has to do with Regulation T, a ... Read Answer >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center