What is short selling?

How it works, step by step

1. You borrow the shares. Your broker locates them for you. You need a margin account: a cash account doesn’t allow short selling.
2. You sell them at the current price. The proceeds stay in your account as part of the collateral.
3. You buy them back later. This is called covering, or closing the short.
4. You return them to the lender. Your result is the difference between the sale price and the buyback price, minus costs.

In practice, all of this happens with one click: the broker handles the loan and the return, and you see the position in your account as a negative quantity.

An example with numbers

Example: you short 100 shares at $60 and receive $6,000.

• If the price drops to $50 and you buy back, you pay $5,000: you make $1,000 before costs.
• If the price rises to $75, buying back costs you $7,500: you lose $1,500.
• If it rises to $120, buying back costs $12,000: you lose $6,000, as much as you received from the sale. And if it keeps rising, the loss keeps growing.

That’s the key difference from a regular purchase: when you buy, the most you can lose is what you paid, because the price can’t go below zero. When you short, there’s no ceiling.

What it’s used for

Besides seeking profits from declines, short selling works as a hedge. An investor with a stock portfolio can open a short in an index ETF to reduce the impact of a broad decline without selling their positions. It also lets you trade both directions of the market: in a clear downtrend, a trader who knows how to short isn’t forced to sit on the sidelines.

Costs and rules

• Borrow fee: an annual rate charged while you hold the short. For hard-to-borrow stocks it can be very high.
• Dividends: if the company pays a dividend while you’re short, you pay that amount to the owner of the shares.
• Collateral: in the United States, Regulation T requires initial collateral equal to 150% of the value sold (the 100% you receive from the sale plus an additional 50%), and after that the broker requires maintenance margin. The exact figures vary by broker and country.
• Early recall: the lender can ask for their shares back, and the broker can close your short even if you don’t want it to.

The risks that hurt most

On top of the unlimited loss, there’s the short squeeze: a fast rally forces many short sellers to buy back to cut their losses, and those purchases push the price even higher. Upside gaps on news can also jump over a stop loss and fill it far above what you planned. Because you’re trading on margin, a strong rally can trigger a margin call and the broker can close the position for you.