How to Short a Stock: Short Selling & Borrowing | The Motley Fool (2024)

Sometimes investors become convinced that a stock is more likely to fall in value than to rise. If that's the case, investors can potentially make money when the value of a stock goes down by using a strategy called short selling. Also known as shorting a stock, short selling is designed to give you a profit if the share price of the stock you choose to short goes down -- but can also lose money for you if the stock price goes up.

How to Short a Stock: Short Selling & Borrowing | The Motley Fool (1)

Image source: The Motley Fool

Why would you short a stock?

Typically, you might decide to short a stock because you feel it is overvalued or will decline for some reason. Since shorting involves borrowing shares of stock you don't own and selling them, a decline in the share price will let you buy back the shares with less money than you originally received when you sold them.

However, there are some other situations in which shorting a stock can be useful. If you own a stock in a particular industry but want to hedge against an industrywide risk, then shorting a competing stock in the same industry could help protect against losses. Shorting a stock can also be better from a tax perspective than selling your own holdings, especially if you anticipate a short-term downward move for the share price that will likely reverse itself.

How to short a stock: 5 steps

In order to use a short-selling strategy, you have to go through a step-by-step process:

  1. Identify the stock that you want to sell short.
  2. Make sure that you have a margin account with your broker and the necessary permissions to open a short position in a stock.
  3. Enter your short order for the appropriate number of shares. When you send the order, the broker will lend you the shares and sell them on the open market on your behalf.
  4. At some point, you'll need to close out your short position by buying back the stock that you initially sold and then returning the borrowed shares to whoever lent them to you, via your brokerage company.
  5. If the price went down, then you'll pay less to replace the shares, and you keep the difference as your profit. If the price of the stock went up, then it'll cost you more to buy back the shares, and you'll have to find that extra money from somewhere else, suffering a loss on your short position.

A simple example of a short-selling transaction

Here's how short selling can work in practice: Say you've identified a stock that currently trades at $100 per share. You think that stock is overvalued, and you believe that its price is likely to fall in the near future. Accordingly, you decide that you want to sell 100 shares of the stock short. You follow the process described in the previous section and initiate a short position.

When you sell the stock short, you'll receive $10,000 in cash proceeds, less whatever your broker charges you as a commission. That money will be credited to your account in the same manner as any other stock sale, but you'll also have a debt obligation to repay the borrowed shares at some time in the future.

Now let's say that the stock falls to $70 per share. Now you can close the short position by buying 100 shares at $70 each, which will cost you $7,000. You collected $10,000 when you initiated the position, so you're left with $3,000. That represents your profit -- again, minus any transaction costs that your broker charged you in conjunction with the sale and purchase of the shares.

What are the risks of shorting a stock?

Keep in mind that the example in the previous section is what happens if the stock does what you think it will -- declines.

The biggest risk involved with short selling is that if the stock price rises dramatically, you might have difficulty covering the losses involved. Theoretically, shorting can produce unlimited losses -- after all, there's not an upper limit to how high a stock's price can climb. Your broker won't require you to have an unlimited supply of cash to offset potential losses, but if you lose too much money, your broker can invoke a margin call -- forcing you to close your short position by buying back the shares at what could prove to be the worst possible time.

In addition, short sellers sometimes have to deal with another situation that forces them to close their positions unexpectedly. If a stock is a popular target of short sellers, it can be hard to locate shares to borrow. If the shareholder who lends the stock to the short seller wants those shares back, you'll have to cover the short -- your broker will force you to repurchase the shares before you want to.

Related investing topics

What Is a Hedge Fund?When wealthy investors put their money together to beat the market.
Selling Stock: How Capital Gains Are TaxedSelling stock can mean capital gains tax. What is it, and how do you minimize it?
Bull vs. Bear Market: What's the Difference?So which animal is the market emulating, and what does each mean?

Be careful with short selling

Short selling can be a lucrative way to profit if a stock drops in value, but it comes with big risk and should be attempted only by experienced investors. And even then, it should be used sparingly and only after a careful assessment of the risks involved.

Expert Q&A

How to Short a Stock: Short Selling & Borrowing | The Motley Fool (2)

Sofia Johan

Associate Professor at FAU's College of Business

The Motley Fool: Short selling can be risky, but also lucrative. What are the top benefits and risks to consider when shorting a stock?

Johan: The risk/reward trade-off isn't new to any investor, but in short selling I find lack of understanding of the risks. The benefit is simple. As an investor, you are not only able to profit by purchasing shares when prices are rising, but also when prices are falling. It isn't a new strategy for more sophisticated investors, but I think unfortunately recent events have highlighted the beauty of short selling to retail investors. I read somewhere recently that up to a quarter of the trading volume in the U.S. equity markets is short positions. The benefits of shorting the market, if done well, do not only apply to investors. Yes, you are, as an investor, "profiting from misery," but you also are providing liquidity to the market. Short positions make pricing easier for market participants, thus potentially preventing other investors from overpaying. The risk is that many investors do not necessarily understand how the market works, for example how market manipulation can exacerbate risk.

The Motley Fool has a disclosure policy.

How to Short a Stock: Short Selling & Borrowing | The Motley Fool (2024)


How do you borrow stock for short selling? ›

In some cases, all you have to do is enter a short order with your brokerage. If available they will lend you the shares and automatically sell them at the current market price. Note that in order to borrow and short stocks, you must have a margin trading account with your broker.

How to short sell successfully? ›

Successful short selling relies on thorough market analysis. This involves understanding market trends, financial statements, and other indicators that suggest a stock might decrease in price. Entering and exiting positions at the right moment can make the difference between profit and loss.

Does Motley Fool actually beat the market? ›

Does Motley Fool beat the market? Yes, Motley Fool stock picks have historically beat the market significantly. Their Stock Advisor picks have returned over 5x more than the S&P 500 over the past 20 years.

What is the best way to explain shorting a stock? ›

To summarize, short selling is the act of betting against a stock by selling borrowed shares and then repurchasing them at a lower cost and returning them later. It's a relatively sophisticated (and risky) trading maneuver that requires a margin account and a keen understanding of the stock market.

What is a hard to borrow short stock? ›

A hard-to-borrow stock is used to indicate what stocks are difficult to borrow for short sale transactions. If you are short selling a ''hard-to-borrow" stock, you'll have to pay a daily stock borrow fee, which changes based on the stock's price and its availability.

How does shorting work for dummies? ›

Short selling is—in short—when you bet against a stock. You first borrow shares of stock from a lender, sell the borrowed stock, and then buy back the shares at a lower price assuming your speculation is correct. You then pocket the difference between the sale of the borrowed shares and the repurchase at a lower price.

What is the 10% rule for short selling? ›

The Alternative Uptick Rule

The rule is triggered when a stock price falls at least 10% in one day. At that point, short selling is permitted if the price is above the current best bid. 1 This aims to preserve investor confidence and promote market stability during periods of stress and volatility.

Why is short selling difficult? ›

Because in a short sale, shares are sold on margin, relatively small rises in the price can lead to even more significant losses. The holder must buy back their shares at current market prices to close the position and avoid further losses.

How to practice short selling? ›

The traditional method of shorting stocks involves borrowing shares from someone who already owns them and selling them at the current market price – if there is a fall in the market price, the investor can buy back the shares at a lower price, and profit from the change in value.

What is The Motley Fool's top 10 picks? ›

See the 10 stocks

The Motley Fool has positions in and recommends Alphabet, Amazon, Chewy, Fiverr International, Fortinet, Nvidia, PayPal, Salesforce, and Uber Technologies. The Motley Fool recommends the following options: short March 2024 $67.50 calls on PayPal.

What are Motley Fool's double down stocks? ›

"Double down buy alerts" from The Motley Fool signal strong confidence in a stock, urging investors to increase their holdings.

What is the best stock picking service? ›

Let's jump in!
  • Best overall: Motley Fool Stock Advisor. ...
  • Best quant-driven service: Alpha Picks. ...
  • Best for portfolio management: The Barbell Investor. ...
  • Best for a high-caliber team of analysts: Moby. ...
  • Best for disruptive technology: Motley Fool Rule Breakers. ...
  • Best for long-term swing trades: Ticker Nerd.
Mar 18, 2024

How do you borrow a stock to short sell for beginners? ›

Make sure that you have a margin account with your broker and the necessary permissions to open a short position in a stock. Enter your short order for the appropriate number of shares. When you send the order, the broker will lend you the shares and sell them on the open market on your behalf.

What is a good shorting strategy? ›

Entering within a Trading Range and Waiting for a Breakdown:

You should short sell securities when the price breaks below a support level because that clearly indicates that the bear is controlling the market. A breakdown will be usually followed sharp declines, so it is advisable that you short sell and wait for it.

What is the math of shorting a stock? ›

The gain or loss on the covered short position during that week is applied to the balance. (Previous closing price - short cover price) x number of shares + balance = new ending balance.

How much does it cost to borrow stocks to short-sell? ›

You'll pay the broker's rates on margin loans, which may run higher than 10 percent annually. Cost of borrow: Short sellers are also charged a “cost of borrow” for shares they are lent. That may be a charge of just a few percent annually, though on highly popular shorted stocks, it may surge to over 20 percent.

Why would you lend stock to a short seller? ›

Lending your stocks to short sellers can generate extra income from your long-term holdings, but be sure you understand the risks and other considerations before you get started. Most investors purchase a stock hoping it'll rise in value—but short sellers want the opposite.

Can you short-sell without borrowing? ›

In essence, you deliver borrowed shares. Another form is to sell stock that you do not own and are not borrowing from someone. Here you owe the shorted shares to the buyer but "fail to deliver." This form is called naked short selling.

Where do short sellers get their shares? ›

To short-sell a stock, you borrow shares from your brokerage firm, sell them on the open market and, if the share price declines as hoped and anticipated, buy them back at the depressed price. Then, you give them back to your brokerage and pocket the difference, less any costs and fees.


Top Articles
Latest Posts
Article information

Author: Rev. Porsche Oberbrunner

Last Updated:

Views: 5811

Rating: 4.2 / 5 (53 voted)

Reviews: 84% of readers found this page helpful

Author information

Name: Rev. Porsche Oberbrunner

Birthday: 1994-06-25

Address: Suite 153 582 Lubowitz Walks, Port Alfredoborough, IN 72879-2838

Phone: +128413562823324

Job: IT Strategist

Hobby: Video gaming, Basketball, Web surfing, Book restoration, Jogging, Shooting, Fishing

Introduction: My name is Rev. Porsche Oberbrunner, I am a zany, graceful, talented, witty, determined, shiny, enchanting person who loves writing and wants to share my knowledge and understanding with you.