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investing-basics

What is Short Selling?

Matthew Levy
Matthew Levy

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.¹

The process of short selling

  1. An investor borrows shares from a broker and "short" sells them, receiving proceeds from the sale in cash. The investor is effectively holding negative shares. The investor has to pay interest charges for borrowing these shares.
  2. The investor may invest the proceeds or keep it as cash.
  3. To close the position (repaying the broker), the investor buys the shares back in the open market and returns them to the broker along with any outstanding interest.
  4. In order for the investor to make a profit from the short sale, they would need to repurchase the shares at a lower price than what they originally sold them for. The profit would need to be adjusted less interest paid to arrive at the net profit figures. If the repurchase price was higher than the original sell price this would result in a loss.

The risk with a short sale is that the share price can rise to any level, exposing an investor to an infinite loss.

Example

Hubert owns 100 shares of ABC stock at $10 a share from a broker. Hubert then sells the 100 shares in the open market at $10 a share. Hubert is now “short” 100 shares of ABC stock. A month later, the price of ABC stock drops to $5. To close his position, Hubert repurchases 100 shares of ABC stock in the open market for $5 a share. He then returns the 100 shares of ABC to the broker, making a profit of $500 ($10 - $5/share = $5 x100 shares =$500), excluding commissions and interest.1 Instead of selling the stock outright, he shorts.

Source

1 Short Selling. Investopedia.


Please note that this article is for general informational purposes only. All examples are hypothetical and for illustrative purposes only. The views and opinions expressed are those of the author and do not reflect or represent the views and opinions of Alpaca. Alpaca does not recommend any specific securities or investment strategies.

All investments involve risk and the past performance of a security, or financial product does not guarantee future results or returns. Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market. There is always the potential of losing money when you invest in securities, or other financial products. Investors should consider their investment objectives and risks carefully before investing.

Brokerage services are provided by Alpaca Securities LLC ("Alpaca Securities"), member FINRA/SIPC, a wholly-owned subsidiary of AlpacaDB, Inc. Technology and services are offered by AlpacaDB, Inc.

This is not an offer, solicitation of an offer, or advice to buy or sell securities, or open a brokerage account in any jurisdiction where Alpaca Securities is not registered (Alpaca is registered only in the United States).

investing-basics

Matthew Levy

Matthew Levy is a Chartered Financial Analyst (CFA) designation holder, a former portfolio manager for $600+ MM in assets, and started his own business writing financial analysis for clients worldwide