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In short selling, a position is opened by borrowing shares of a stock or other asset that the investor believes will decrease in value. The investor then sells these borrowed shares to buyers willing to pay the market price. Before the borrowed shares must be returned, the trader is betting that the price will continue to decline and they can purchase the shares at a lower cost. 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. It can offer big profits, but losses can mount quickly and infinitely due to margin calls. To open a short position, a trader must have a margin account and will usually have to pay interest on the value of the borrowed shares while the position is open.

If an investor’s account value falls below the maintenance margin, more funds are required, or the position might be sold by the broker. The process of locating shares that can be borrowed and returning them at the end of the trade is handled behind the scenes by the broker. Opening and closing the trade can be made through the regular trading platforms with most brokers. However, each broker will have qualifications that the trading account must meet before they allow margin trading. The most common reasons for engaging in short selling are speculation and hedging. A speculator is making a pure price bet that it will decline in the future.

If they are wrong, they will have to buy the shares back higher, at a loss. People may also sell short to hedge a long position. 50—will decline in price in the next three months. They borrow 100 shares and sell them to another investor. 100 shares since they sold something that they did not own but had borrowed. 40 on the open market to replace the borrowed shares. 40 but decided to leave it open to capitalize on a further price decline.

65 per share, and the stock soars. Here, the trader had to buy back the shares at a significantly higher price to cover their position. Apart from speculation, short selling has another useful purpose—hedging—often perceived as the lower-risk and more respectable avatar of shorting. The primary objective of hedging is protection, as opposed to the pure profit motivation of speculation.

The costs of hedging are twofold. There’s the actual cost of putting on the hedge, such as the expenses associated with short sales, or the premiums paid for protective options contracts. Also, there’s the opportunity cost of capping the portfolio’s upside if markets continue to move higher. Selling short can be costly if the seller guesses wrong about the price movement.

Also, while the stocks were held, the trader had to fund the margin account. When it comes time to close a position, a short seller might have trouble finding enough shares to buy—if a lot of other traders are also shorting the stock or if the stock is thinly traded. Conversely, sellers can get caught in a short squeeze loop if the market, or a particular stock, starts to skyrocket. On the other hand, strategies that offer high risk also offer a high-yield reward.

Beginning investors should generally avoid short selling until they get more trading experience under their belts. Besides the previously mentioned risk of losing money on a trade from a stock’s price rising, short selling has additional risks that investors should consider. When short selling, you open a margin account, which allows you to borrow money from the brokerage firm using your investment as collateral. Even though a company is overvalued, it could conceivably take a while for its stock price to decline. In the meantime, you are vulnerable to interest, margin calls, and being called away. Regulators may sometimes impose bans on short sales in a specific sector, or even in the broad market, to avoid panic and unwarranted selling pressure. Such actions can cause a sudden spike in stock prices, forcing the short seller to cover short positions at huge losses.

History has shown that, in general, stocks have an upward drift. Over the long run, most stocks appreciate in price. Unlike buying and holding stocks or investments, short selling involves significant costs, in addition to the usual trading commissions that have to be paid to brokers. Margin interest can be a significant expense when trading stocks on margin.