Short Selling Definition: An Explanation of Shorting Stock

The hope behind shorting a stock is that the stock price will decline or that the company will go bankrupt, leading to total ruin for the equity holders. This guide will explain what is short selling and how to short stocks for speculations or hedging.

What is short-selling?

Short-selling is the act of selling an asset that you do not currently own, in the hope that it will decrease in value and you can close the trade for a profit. It is also known as shorting. Short-sellers tend to use this strategy as a method of speculation or as a way of hedging downside risk.

Short-selling strategies can be carried out via a broker, but it is a complicated method, which means that it can be difficult to find a broker willing to lend you the shares to sell. This is why derivative products such as CFDs are becoming an increasingly popular method of short-selling.

Continue reading or play around with a stock simulator and practice short-selling without any risk or financial obligations. 


Example of short-selling

Let’s say that the shares of company ABC are currently trading at $75, but you believe that they are going to decline in value and decide to short-sell the stock. You borrow 100 shares of ABC from your broker and sell them on the open market.

Over the next week, the market drops significantly down to $40, so you close your short position and buyback 100 shares of ABC at $40 each.

You calculate the difference between the price of the shares when you borrowed them (75 x 100 = $7500) and the price that you re-bought the shares for (40 x 100 = 4000), which gives you a profit of $3500 – excluding any commissions and costs your broker may charge.

However, if you had been incorrect and the market had continued to rise, your potential risk is infinite. Because you have borrowed the stock, your broker may ask for them back at any time and you would have to close out your position at a loss. 

Read our guide on how to buy shares to profit twice.

Pros and cons of short-selling

Pros of short-selling

Short-selling means that you have the opportunity to profit from markets that are declining in value, not just ones that are increasing.

Short-selling can be carried out in a variety of ways. The example above demonstrates the traditional method of short-selling via a broker, but traders will define short-selling slightly differently to investors. Thanks to the rise of online trading and derivative products – such as CFDs – traders can take a short position on thousands of markets without having to borrow the underlying asset.

They can be used in a speculative manner, taking naked short positions, or for hedging purposes.

With AM Broker there is NO extra charge on short sales while the commission is 1$ per 100 shares traded short or long.  

>> Open a short-selling stock account

Cons of short-selling

Short-selling can be a risky strategy, as assets can theoretically increase in value indefinitely. Leveraged products can increase the risk further, amplifying losses when a market is heading upwards in price.

A good risk management is key when short-selling, using tools like trailing stops to prevent excessive losses. Using a trailing stop-loss order on the stock trading app will incur a fee if the stop is triggered.

There’s also a recall risk, in the event that the stock lender wants to liquidate their position and therefore recalls the stock lent out, which in turn forces the borrower to liquidate their position at a potentially unfavorable time.

You can not earn dividends on short positions.

Short-selling tips

In order to get the most out of the market via short-selling, it’s important that you do extensive planning and have a solid strategy. We have put together a few tips to get you started.

  • Do a complete fundamental and technical analysis on the market before you decide to go short
  • Be mindful of your position size – the larger it is, the more risk is involved. However, if the position is very small, you might not make a visible profit
  • Set up trading alerts that will notify you when your market hits a certain level and then lets you decide what to do next
  • Place trailing stops that will follow your position if it earns a profit and close if it reverses
  • Place guaranteed stops to close your position once it rises to a certain point. This puts a limit to your downside and you’ll only have to pay a small charge if your stop is triggered

Short-selling summed up

We have summarised a few key points to remember on short-selling below.

  • You can go short on a market of your choice, via CFD trading (the most cost-effective option), or by borrowing stock from a broker
  • If the underlying market price dips, you could make a profit
  • It’s important to have the appropriate risk management tools in place to avoid big losses
  • In a nutshell, you can use short-selling to speculate on falling market prices – giving you the opportunity to profit from bear markets as well as bull runs.

Understanding what is short-selling and how does it work is important, but if you need help MT5 AM Broker provides short-selling with no extra charge and advanced tools for speculations and hedging strategies. Additionally, use an Expert Advisor Generator to create automated short-selling strategies with a few clicks, without writing codes.

Risk-Free Short-Selling with $10,000 in Virtual Cash

The number of people short-selling stocks, commodities, ETFs and other financial instruments for a living has surged. Is it realistic though? The answer is, it depends entirely on your ambition and commitment. It won’t be an easy ride. But, if it suits your working style, you choose the right market and you utilize the tips mentioned, then you could be one of the few that triumph.

Put your trading skills to the test with our FREE Stock Simulator. Compete with thousands of online traders and trade your way to the top! Submit short trades in a virtual environment before you start risking your own money. Practice short-selling strategies so that when you're ready to enter the real market, you've had the practice you need.

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