For many investors, experienced and novice alike, the idea of short selling stocks can be enticing. You can make money investing even if the stock market is in a downturn. You can earn a profit on days when others are losing money.
But selling a stock short can severely punish investors — especially if they don’t understand the risks.
What Is Short Selling?
You can win on a bet — no matter which way the stock is moving — as long as you’re guessing the right direction. Short selling allows you to invest in stocks even when you think that their share price will decrease.
Unlike typical long investors, who buy hoping that share prices will increase, being on the short side of the position, or a short seller,
is the exact opposite. You’re actually counting on the shares decreasing in value. Naturally, that’s a little counterintuitive for many investors.
When you think that a stock’s price will decline, you can tell your brokerage firm to short the stock for you. Essentially, you’re borrowing shares from the brokerage and then selling them; when — or rather, if — the price declines, you purchase the shares yourself at a lower price, return those “borrowed shares” to the brokerage, and lock in your profit. The brokerage earns a commission on the transaction and a small amount of interest in most cases, depending on how long you borrow the stock.