Short Selling

Short selling, or shorting, is an investment strategy that profits from a security's price decline. It involves borrowing shares from another investor, selling them immediately at current market prices, and later buying back the shares (hopefully at a lower price) to return them. The profit is the difference between the selling price and the repurchase price. Here's how it works: You believe XYZ stock, currently trading at $100, will decline. You borrow 100 shares from your broker and sell them for $10,000. If the stock falls to $70, you buy back 100 shares for $7,000, return them to the lender, and pocket $3,000 profit (minus borrowing costs and commissions). However, if the stock rises to $130, you'd need $13,000 to close the position, resulting in a $3,000 loss. Short selling serves important market functions. It provides liquidity and can help correct overvaluations. Short sellers often do extensive research, sometimes uncovering fraud or accounting problems that others miss. Their selling pressure helps prevent bubbles from inflating further. The risks of short selling are substantial. While a stock can only fall to zero, limiting maximum profit, it can rise indefinitely, creating theoretically unlimited potential losses. Short sellers also pay borrowing costs and may receive margin calls forcing them to add capital or close positions at unfavorable times. Short squeezes - rapid price increases forcing shorts to cover - can cause massive losses quickly. Regulators have at times restricted short selling during market crises, arguing it can exacerbate downturns. Short sellers have also faced public criticism when their actions drive down prices of popular stocks. The GameStop saga of 2021 highlighted conflicts between short sellers and retail investors. For most individual investors, short selling is too risky and complex. Those who believe a stock will decline might instead buy put options, which provide downside exposure with limited risk, or simply avoid or sell the stock rather than betting against it.