What is Shorting A Stock with Example?

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“Shorting” is a method of investing that allows traders to speculate on the direction of a company’s future performance. That is to say, if you’re ready to take a calculated risk, the reward could be substantial. Considerations such as the company’s financial health, the quality of its management, and its projected growth would likely factor into a long-term investor’s final selection. Shorting a stock is essentially betting against its value, as the investor expects the price to go down.

You can hedge your bets by shorting a stock. Say you’re a stockholder who is hesitant to cash out because they fear the company’s future success may be uncertain. In this example, you could short the stock, hold onto your shares indefinitely, and then repurchase them at a lesser price if and when the stock’s price drops. The objective here is to recover any money you may have lost on your long position.

Short selling occurs when an investor borrows shares from a broker with the intent of selling them immediately. The investor anticipates a decline in the stock price in the near future. If that happens, the broker will accept the shares back at a cheaper price, and the trader will pocket the difference. For a clearer understanding of the stock topic, keep reading.

What is Shorting A Stock?

The goal of short selling is to profit from a drop in the market price of a stock or other security. This complex method suits seasoned traders. Short selling, for speculation or hedging, is used by investors and portfolio managers. Hedging curbs loss on a long position. Trading speculation can lead to heavy losses, while hedging mitigates risk.

To engage in short selling, a trader borrows shares of a stock or other asset from a third party with the expectation that the value of the asset will decline. An investor who borrows stock sells it to buyers at the going market price. The trader anticipates the share price to keep dropping before returning the borrowed shares. Since an asset’s price can theoretically increase to infinity, the potential loss on a short sell is also infinite.


A short position starts by borrowing shares, often from a broker-dealer, with the aim to buy them back at a lower price. Profit comes from the security’s price drop. In order to make a sale, you need access to shares that do not currently belong to you.

When a trader wants to get out of a short position, he or she will buy the shares back on the market and return them to the broker or lender, ideally at a lower price. Traders should keep a record of all fees and commissions paid to the broker. The profit potential in shorting a stock comes from the difference between the selling price and the eventual repurchase price.

Starting a short position requires a margin account and usually involves paying interest on borrowed shares. The Federal Reserve, the New York Stock Exchange (NYSE), and Financial Industry Regulatory Authority, Inc. (FINRA), the organization responsible for enforcing rules and regulations for registered brokers and broker-dealer firms in the United States, have all established minimum values for the amount that the margin account must maintain. What we’re talking about here is the preservation margin. To avoid their broker selling their position, an investor must raise the maintenance margin when their account value falls below it.

The broker conducts all the legwork to locate shares that can be borrowed and returns them after the trade is complete. The majority of brokers provide their clients with access to industry-standard trading platforms. However, in order to trade on margin, your trading account must first match the criteria set forth by your broker.

Examples of Shorting A Stock

A short squeeze arises from unexpected news, driving short sellers to buy regardless of price. Volkswagen’s 1990s short squeeze exemplified this. Amid a takeover suspicion by Porsche, short sellers covered their positions as Porsche unveiled a 70% stake, causing a buying spree. With 20% government control and 70% Porsche stake, few available shares hampered short sellers. The stock surged from €200s to €1,000+ overnight, driven by high short interest. The squeeze lasted months, and the stock eventually normalized. Shorting a stock requires careful analysis and market timing.

Another example: To make $100, you borrow 10 shares of a firm (or ETF, or REIT), which you promptly sell on the stock market. You could return all 10 shares to your broker for a total of $500 if the price decreases below $5 per share, after which you would have spent $100. You made $50 in total from the short sale. (after deducting all necessary fees and interest)

Why Short Sell?

When selling short, most people are doing so for speculative or defensive reasons. Someone who bets that the price will drop in the future is called a “speculator.” Buying the stock at a higher price means losing money if they are wrong. Short sales on margin are riskier due to their shorter duration, often for speculation.

In order to safeguard a long position, some investors choose to short sell. If you’re long a security and have call options, for instance, you could sell short against that long position to secure your profits. Limit losses on a long stock position by short selling a related stock, without selling the original.

Profitable Short Selling

Just imagine a trader who is convinced that the present $50 price of XYZ stock would fall by the end of the next quarter. They borrow 100 shares and then sell them to another investor. The trader is “short” 100 shares since they sold something they did not own and had borrowed. When others are shorting the same stock, borrowing stock for short sales can become impractical.

A week later, the shorted company announces poor quarterly financial results, and its stock price drops to $40. The investor chooses to buy 100 shares on the open market for $40 to cover the short position and return the borrowed shares. Since the short sell netted $1,000 ($50 minus $40 = $10 x 100 shares = $1,000), the trader made $1,000 after deducting commissions and interest on the margin account.

Hedging with Short Sales

There are practical applications for short selling beyond pure speculation. Comparing hedging to shorting is common, with the former seen as safer and more reputable. Hedging prioritizes safety, while speculation seeks profit. Due to the high cost involved, most individual investors ignore the possibility of hedging their portfolios during normal market conditions, despite the fact that this strategy can significantly mitigate the impact of adverse market movements.

To hedge means to pay twice as much. There is the outlay of resources necessary to implement the hedge, which may include the price of short sales or the premium on protective options contracts. Limiting the portfolio’s potential growth if markets keep rising is also costly in terms of missed opportunities. If half of a portfolio that is highly correlated with the S&P 500 index (S&P 500) is hedged and the index rises 15% over the next 12 months, the portfolio will only rise by around half of that, or 7.5%.

Expense-Inducing Short Sale

So, in the preceding illustration, the trader might have chosen to avoid taking a loss by closing out the short position at $40 and instead kept it open in the event that the price fell even more. But then a rival corporation offers $65 per share to buy it out, and the stock price skyrockets.

If the trader decides to close the short position at $65 (from $50 to $65), the loss on the short sale is $1,500 ($50 minus $65 = -$15, multiplied by 100 shares). The trader in this example was forced to cover their position by repurchasing the shares at a considerably higher price. However, shorting a stock comes with risks, as there’s no limit to how high a stock’s price can go, potentially leading to unlimited losses.

Compact Grasps

If several other traders are shorting the same stock, or if the stock is not actively traded, it may be difficult for a short-seller to obtain enough shares to buy in order to close a position. Conversely, sellers might become caught in a short squeeze cycle if the market or a specific stock begins to soar.

High-risk strategies can lead to significant rewards, even in short selling. Correct price movement predictions and margin use can offer excellent ROI. Margin provides leverage for traders, requiring less upfront capital. Prudent short selling can hedge losses and stabilize investing strategies affordably. Before gaining more experience, novice investors should usually avoid short selling. However, the risk of a short squeeze is reduced by selling short through exchange-traded funds.

Why Borrow Shares for Short-Selling?

Selling a nonexistent product is impossible. Since there is a finite number of shares in circulation, a short seller must first locate some of them. So, the short seller borrows the stock from an existing shareholder and pays interest to the lender. A broker’s behind-the-scenes assistance is common in this regard.

Interest charges to sell short will be higher if it is difficult to borrow shares to sell short, as this indicates that there are not many shares available for short sale. Shorting a stock technique involves borrowing shares from a broker and immediately selling them in the open market.


Time is of the essence when short selling. Typically, stock prices fall at a considerably faster rate than they rise, and a large gain in a company can be erased in a matter of days or weeks if profits fall short or something else negative occurs. Short sellers must therefore have nearly flawless timing in order to make a profit. A large portion of the stock’s loss may have already occurred if you wait too long to purchase.

The information provided by short-sellers typically helps the market establish a more accurate assessment of a company’s prospects. This can keep the stock price lower than it would be if there were simply cheerleaders in the stands. Short sellers play an important role in preventing over-exuberance among investors by exposing fraudulent activity, questionable accounting practises, and other signs of badly managed businesses. The company’s SEC filings can contain this info. These are all crucial aspects of the functioning of the financial markets.

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