What Is Short Selling?
  1. Short Selling Guide: Introduction
  2. What Is Short Selling?
  3. Example of a Short Selling Transaction
  4. Short Selling Strategies and Margin
  5. Timing a Short Sale
  6. Short Selling Analytics
  7. Short Selling Alternatives
  8. Risks of Short Selling
  9. Ethics And The Role Of Short Selling
  10. Short Selling Guide: Conclusion

What Is Short Selling?

First, let's describe what short selling means when you purchase shares of stock. In purchasing stocks, you buy a piece of ownership in the company. The buying and selling of stocks can occur with a stock broker or directly from the company. Brokers are most commonly used. They serve as an intermediary between the investor and the seller and often charge a fee for their services.

When using a broker, you will need to set up an account. The account that's set up is either a cash account or a margin account. A cash account requires that you pay for your stock when you make the purchase, but with a margin account the broker lends you a portion of the funds at the time of purchase and the security acts as collateral.

When an investor goes long on an investment, it means that he or she has bought a stock believing its price will rise in the future. Conversely, when an investor goes short, he or she is anticipating a decrease in share price.

Short selling is the selling of a stock that the seller doesn't own. More specifically, a short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered. That may sound confusing, but it's actually a simple concept. (To learn more, read: Benefit From Borrowed Securities.)

When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later, you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.

Most of the time, you can hold a short for as long as you want, although interest is charged on margin accounts, so keeping a short sale open for a long time will cost more. Moreover, you can be forced to cover if the lender wants the stock you borrowed back. Brokerages can't sell what they don't have, so you will either have to come up with new shares to borrow, or you'll have to cover. This is known as being called away. It doesn't happen often, but is possible if many investors are short selling a particular security.

Because you don't own the stock you're short selling (you borrowed and then sold it), you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stock splits during the course of your short, you'll owe twice the number of shares at half the price. If you want learn more about the basics of investing you can sign up to our free Investing Basics newsletter.

Example of a Short Selling Transaction

  1. Short Selling Guide: Introduction
  2. What Is Short Selling?
  3. Example of a Short Selling Transaction
  4. Short Selling Strategies and Margin
  5. Timing a Short Sale
  6. Short Selling Analytics
  7. Short Selling Alternatives
  8. Risks of Short Selling
  9. Ethics And The Role Of Short Selling
  10. Short Selling Guide: Conclusion
RELATED TERMS
  1. Buy To Cover

    A buy order made on a stock or other listed security that closes ...
  2. Margin Account

    A brokerage account in which the broker lends the customer cash ...
  3. Short Sale

    A market transaction in which an investor sells borrowed securities ...
  4. Short Covering

    Buying back borrowed securities in order to close an open short ...
  5. Short Selling

    Short selling is the sale of a security that is not owned by ...
  6. Short (or Short Position)

    A short position is the sale of a borrowed security, commodity ...
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. How does somebody make money short selling?

    Short selling is a fairly simple concept: you borrow a stock, sell the stock and then buy the stock back to return it to ... Read Answer >>
  4. Can you short sell stocks that are trading below $5? My broker says that I can't.

    Short selling can be very risky for both the investor and the broker. Brokers will often tell investors that only stocks ... Read Answer >>
  5. How can you lose more money than you invest shorting a stock? If you have no money ...

    The simple answer to this question is that there is no limit to the amount of money you can lose in a short sale. This means ... 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 >>

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