What is Short selling?
About this lesson
In this video, we will discuss what short selling means, when an investor goes short, and the loss potentials of a short sale transaction. As always, I will show a numeric example so that you understand the concept better.
How a short sale works
Normally you buy a stock first and sell it later (“buy low, sell high”). A short sale reverses the order: sell first, buy later.
- Your broker lends you shares owned by someone else.
- You sell the borrowed shares at today’s price.
- Later, you buy the same number of shares back (called covering the short).
- You return the shares to the lender.
You profit if the price falls between steps 2 and 3.
When investors go short
- They believe a stock is overvalued and likely to fall.
- They want to hedge: protect other holdings against a market drop.
Example
You short 100 shares at $50, receiving $5,000.
| Price when you cover | Cost to buy back | Profit or loss |
|---|---|---|
| $40 | $4,000 | +$1,000 |
| $50 | $5,000 | $0 |
| $70 | $7,000 | −$2,000 |
The risks
- Unlimited loss potential: a stock can only fall to $0, which caps a short seller’s gain, but it can rise without limit, so the loss has no cap.
- Dividends: if the stock pays a dividend while you’re short, you owe it to the lender.
- Margin calls: short sales happen in a margin account, and you may have to add money if the price rises (see short selling in a margin account).
- Recall: the lender can ask for the shares back, forcing you to cover at a bad time.
This lesson is for education only and isn’t investment advice.
Next: margin trading basics.