Glossary · Stocks and markets

Short selling

Short selling is betting that a price will fall: you borrow shares, sell them now, and hope to buy them back cheaper later to return them.

Also called: shorting, short sale, going short, short position

In plain words

A friend lends you a concert ticket worth $100. You sell it for $100, sure that prices will drop. A week later you buy an identical ticket for $60 and give it back to your friend. You keep $40. That, with shares instead of tickets, is short selling.

A short seller borrows shares through a broker, pays a fee for the loan, sells them at today’s price and later buys them back (“covers”) to return them. If the price fell in between, the seller profits; if it rose, the seller loses.

Normal investing is “going long”: buy first, sell later. Shorting reverses the order: sell first, buy later.

Sell first, buy back later. The gain is capped (the price can only fall to zero); the possible loss is not.

Example

Two ways a short can end

You borrow 100 shares and sell them at $50: you receive $5,000.
The price falls to $40. You buy 100 shares for $4,000 and return them: a profit of $1,000, minus the borrowing fee.
Or the price climbs to $80. Buying back costs $8,000: a loss of $3,000, more than half of what you received.
At $150 the loss would be $10,000. A price can rise without limit, so a short seller’s possible loss has no ceiling.

Buying a share, you can lose at most what you paid. Shorting, you can lose far more than you started with.

One level deeper

Short sellers must keep collateral with their broker; if the price rises, the broker asks for more (a margin call) and may buy the shares back without asking. When many short sellers are forced to buy at once, they push the price up further: a short squeeze, as in GameStop in January 2021.

Short sellers are unpopular with companies, but they play a role: they help prices reflect bad news, and some have exposed frauds, as Jim Chanos did with Enron before its collapse in 2001. Regulators sometimes ban shorting in a crisis, as many did in 2008, with debated results.

Selling shares that have not been borrowed or arranged to be borrowed (“naked” shorting) is restricted in the US. Investors can also bet on falling prices with options or futures without borrowing shares.

Why it matters

It lets investors act on negative views, which makes prices more complete: without it, only optimists could trade.

Hedge funds use it to cut risk: owning one company and shorting a rival is a bet on the difference between them, not on the whole market.

Its unlimited risk is a vivid lesson in how losses can exceed what you put in.

A common mistake

Myth: Short sellers make stocks fall.

In fact: They sell, which adds pressure, but they must buy the shares back later, which adds demand. Studies generally find that short sellers tend to target overpriced shares, and bans on shorting have not stopped falling markets.

Questions people ask

How does short selling work?

You borrow shares through a broker, sell them, and later buy the same number back to return them. You profit if the price falls between the sale and the purchase, minus the borrowing fee and any dividends you must pay the lender.

Is short selling legal?

Yes, in most markets, under rules. In the US the shares must be borrowed, or located for borrowing, first, and under a rule adopted in 2010 extra limits kick in when a stock falls 10% in a day.

What is the most you can lose on a short?

In theory, there is no limit, because a share price can keep rising. In practice your broker will close the position when your collateral runs out, often at a painful price.

About the numbers

This page explains a term. It is not investment advice.