Introduction to short selling

What is short selling?

Short selling is effectively the procedure of betting against certain equities. If investors believe that a company’s share price will decline in the foreseeable future then it is a sensible move to ‘short’ the stock. In this scenario, the investor will make money when the company’s share price falls, and will lose money should the company’s share price increase. 

There are two fundamental reasons that investors may choose to short sell stock. The process can simply be a speculative way of making money from the stock market. And it can also act as a hedge against the downside risk of a long position. 

How does short selling compare to going long?

Short selling is the polar opposite of going long. Investors that maintain a long position in a stock believe that its share price will increase. 

Another important distinction is that going long involves actually purchasing the stock in question. When short selling, investors naturally do not purchase or hold the stock, as they are effectively betting against its success. Whereas when you take a long position, you own the security with the hope that it will appreciate in value over a period of time.

How do you short a share?

There are various ways to do this in the contemporary market, but the traditional method involves borrowing shares from an investing owner, and then selling them at the current market price. If there is a fall in the market price, the investor can then buy back the shares at a lower price, profiting form the change in value.

However, modern methods of trading mean that there are other short selling options available today. For example, it is possible to short sell via derivatives – these are financial securities with value derived from an underlying asset. Short selling via this approach simply involves opening a trading account, and opening selling position in the stocks that you wish to short.