What is shorting a share

There's a ceiling on your potential profit, but there's no theoretical limit to the losses you can suffer. And if you think losses like this aren't possible, think again. Still, even though short-selling is risky, it can be a useful way to take calculated positions against a particular company for investors who know what they're doing.

Managing your risk is important, but when used in moderation, short-selling can diversify your investment exposure and give you an opportunity to capture better returns than someone who only owns stocks and other investments.

As a final thought, an alternative to shorting that limits your downside exposure is to buy a put option on a stock. Essentially, a put option gives you the right, but not the obligation, to sell a stock at a predetermined price known as the strike price at any time before the option contract expires.

So, the idea behind buying a put option is similar to shorting, although the most you can possibly lose is what you pay for the put option. Now, there's more to trading options than I can explain here, so do your homework if this is a strategy that sounds appealing to you. But it can be a smart alternative to the unlimited loss exposure that comes with shorting a stock.

Her areas of expertise and research interest include legal and ethical issues in financial markets, entrepreneurial finance, and regulation of financial markets around the world. The Motley Fool: What are some common misconceptions about short selling that investors should know? Johan: I think most investors believe the risks to be the same as that of taking long positions.

Definitely not the case. Some risks are, of course, similar, for example trading on misinformation. Short sellers have an incentive to provide false information to push stock price down but remember that for short sellers there is the added cost of borrowing the stock that they have to consider when they succumb to herd mentality. This isn't a new game. Having voting rights due to long positions that enable them to facilitate stock price movements and having setting off capabilities with short positions make for potentially high volatility.

As I mentioned earlier, the market may not be as efficient as the less sophisticated investor thinks. For example, take naked shorts. If the seller never intends to deliver, then theoretically the seller could sell as many shares as the seller wants -- possibly 10 times more than the actual number of floated shares and drive the price down to zero -- until market regulators step in. Discounted offers are only available to new members. Stock Advisor will renew at the then current list price. Investing In , investors knew that Porsche was trying to build a position in Volkswagen and gain majority control.

Short sellers expected that once Porsche had achieved control over the company, the stock would likely fall in value, so they heavily shorted the stock. A short position is one that bets against the market, profiting when prices decline.

To sell short is to take such a bet. This is opposed to a long position, which involves buying an asset in hopes the price will rise. You cannot sell something that doesn't exist, Since a company has a limited number of shares outstanding, a short seller must first locate some of those shares in order to sell them. The short seller, therefore, borrows those shares from an existing long and pays interest to the lender.

This process is often facilitated behind the scenes by one's broker. If there are not many shares available for shorting i. While some people think it is unethical to bet against the market, most economists and financial professionals agree that short sellers provide liquidity and price discovery to a market, making it more efficient. Many brokers allow short selling in individual accounts, but you must first apply for a margin account.

Because short sales are sold on margin, relatively small losses can lead to ever larger margin calls. If a margin call cannot be met, the short must buy back their shares at ever higher prices.

This works to bid the price of the stock even higher. General Electric. Porsche SE. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.

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Trading Order Types. Day Trading Psychology. Table of Contents Expand. What Is Short Selling? Understanding Short Selling. Why Sell Short? Pros and Cons of Short Selling. Additional Considerations with Short Selling.

Costs of Short Selling. Short Selling Metrics. Ideal Conditions for Short Selling. Short Selling's Reputation. Real-World Example of Short Selling. Why Is it Called Selling Short? Is Short Selling Bad? What Is a Short Squeeze? Key Takeaways Short selling occurs when an investor borrows a security and sells it on the open market, planning to buy it back later for less money. Short-sellers bet on, and profit from, a drop in a security's price.

This can be contrasted with long investors who want the price to go up. Pros Possibility of high profits Little initial capital required Leveraged investments possible Hedge against other holdings.

Cons Potentially unlimited losses Margin account necessary Margin interest incurred Short squeezes. Article Sources. Investopedia requires writers to use primary sources to support their work.

These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.

This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Short Squeeze A short squeeze occurs when a stock moves sharply higher, prompting traders who bet its price would fall to buy it in order to avoid greater losses.

Rebate A rebate in a short-sale transaction is the portion of interest or dividends paid by the short seller to the owner of the shares being sold short. It isn't a new strategy for more sophisticated investors, but I think unfortunately recent events have highlighted the beauty of short selling to retail investors.

I read somewhere recently that up to a quarter of the trading volume in the U. The benefits of shorting the market, if done well, do not only apply to investors. Yes, you are, as an investor, "profiting from misery," but you also are providing liquidity to the market. Short positions make pricing easier for market participants, thus potentially preventing other investors from overpaying. The risk is that many investors do not necessarily understand how the market works, for example how market manipulation can exacerbate risk.

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