Next video:
Loading the player...

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

Short covering is part of short selling, which is a risky way to profit from a depreciating stock.

Suppose Harry believes XYZ’s stock is going to drop in value. He borrows 10 shares to sell for $100 each, its current market price.

A month later, XYZ’s stock drops to $50 per share. Harry buys 10 shares at its new price and covers his open short position, or returns the shares he borrowed, making a profit of $500.

Harry predicted XYZ was going to lose value, and he was right. Had the stock risen in value, he’d have been short covering at a higher price than the borrowed shares he sold.

A short squeeze may occur on stocks with a lot of short covering. A short squeeze forces short sellers to cover their positions earlier than they planned, before the stock’s value climbs too high. Short sellers usually have a shorter trading horizon than investors who buy a stock expecting its value to increase.

Short covering can provide protection in a down market. It usually occurs in the early stages of a rally following a long bear market.

Related Articles
  1. Trading

    Short interest: What it tells us

    Whether you agree with the overall sentiment or not, short interest is a data point worth adding to you overall analysis of a stock.
  2. Trading

    The Short Squeeze Method

    The short squeezed strategy can be risky - but also very rewarding - for those who master it.
  3. Trading

    Short Squeeze

    A short squeeze refers to a jump in a stock's price, forcing a large number of short sellers to close their position, which in effect pushes the price even higher. When an investor shorts a stock, ...
  4. Investing

    Rules and Strategies For Profitable Short Selling

    Short sales work well in bull and bear markets but strict entry and risk management rules are required to overcome the threat of short squeezes.
  5. Trading

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
  6. Managing Wealth

    Value Investing & Short Selling Are Like Oil & Water

    To be a good value investor, you need to find and buy bargain stocks but more importantly, you have to stick to the trade until the market recognizes the worth of these securities.
  7. Difference Between Short Selling And Put Options

    Short selling and put options are used to speculate on a potential decline in a security or index or hedge downside risk in a portfolio or stock.
  8. Investing

    The Truth About Naked Short Selling

    The media demonizes naked short selling, but it usually occurs after a collapse, not before.
Hot Definitions
  1. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  2. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  3. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  4. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  5. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  6. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
Trading Center