Shorting a stock involves selling a borrowed stock in the anticipation of buying the same stock back at a lower future price and pocketing the difference. Short selling is a normal part of an active trader’s plan as it presents traders with the ability to benefit from an advancing market and a declining one. This article makes use of examples to explain what short selling is, why it is important and lists the top things to consider when short selling stocks.
What is short selling and why do it?
Short selling is the process of borrowing shares via a broker, selling those shares at the current market price and later buying the shares back at a lower price in order to return the shares to the broker.
Why short stocks? The answer to this question is multi-layered but in general, shorting stocks presents an opportunity trade a decline in a share’s price.
To some, short selling seems rather unethical because you are essentially taking a stance that a company’s share price will fall, which could result in large scale retrenchments affecting many households in the process. To others, this represents an opportunity to speculate in on over-valued stocks or to benefit from the largescale selling of unscrupulous companies.
Nowadays, in addition to retail traders, there are well-established hedge funds that focus on short selling, or ‘shorting’ various companies. Some short sellers publish research on companies that are alleged to have reported misleading figures in the publication of financial statements or where there is sufficient evidence of corrupt business practices.
Before diving into the world of short selling, we recommend you review the stock market basics[1].
What does shorting a stock involve?
At this stage it may be helpful to differentiate between short selling stocks in the
