A Basic Description of Short Selling
By Ted Rollins
, last updated December 22, 2011
Short selling, also called going short or shorting, happens when an investor sells assets that he or she borrows from a broker with the plan to buy back an equal number of those assets in the future. In sum, short selling involves buying a negative amount of the stock in anticipation of the stock's price falling, so that the stock can be purchased for less than the amount for which you shorted it. If the stock, however, fails to decrease in price, the owner will lose money. In more general terms, short selling refers to any investment strategy in which an investor plans to benefit from the decrease in the price of an asset in the short or long term; this can happen with derivatives, options, or futures.
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For an example of how a short sale that results in gains for the investor, consider the following example. An investor that believes a company's stock will fall decides to short 10,000 shares of the company's stock at $10 per share, selling them all for a total of $100,000. In a matter or days, the company's stock does indeed fall, going down to $9 per share. The investor decides that he now wants to buy back the 10,000 shares he shorted, doing so for a total of $90,000. He or she returns the shares to his lender, having made $1 per share for a total of $10,000. However, the total profit for the investor will be less than $10,000 due to borrowing fees and any transaction fees. However, if the company's stock had gone up to $15, that same investor would be compelled to buy 10,000 shares at that price, paying $150,000 and incurring a loss of $50,000, plus any fees for making the deal.
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