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A Beginner’s Guide to Shorting the Stock Market

Shorting a Stock

When you’re ready to exit the trade, use a “buy to cover” order to buy and return the borrowed shares. If the stock goes to zero, you’ll get to keep the full $1,000. However, if the stock soars to $100 per share, you’ll have to spend $10,000 to buy the 100 shares back. That will give you a net loss of $9, nine times as much as the initial proceeds from the short sale. And if you think losses like this aren’t possible, think again. The short-seller hopes that the price will fall over time, providing an opportunity to buy back the stock at a lower price than the original sale price.

Shorting a Stock

However, relatively few investors use the short-selling strategy. The SEC warns that most traders lose money in their first months of trading, and many never turn a profit. When a broker facilitates the delivery of a client’s short sale, the client is charged a fee for this service, usually a standard commission similar to that of purchasing a similar security. If an investor shorts a stock, there is technically no limit to the amount they could lose because the stock can continue to go up in value indefinitely. In some cases, investors could even end up owing their brokerage money. John Maynard Keynes was an influential British economist whose economic theories are still in use today.

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This occurs when there’s a price spike in a stock that’s been heavily short sold, which puts pressure on short sellers to close out their positions to minimize losses. In so doing, short sellers buying back the stock help spur further gains in the stock’s price. Of course, assets can stay overvalued for long periods of time, and quite possibly longer than a short seller can stay solvent. Assume that a trader anticipates companies in a certain sector could face strong industry headwinds 6 months from now, and they decide some of those stocks are short-sale candidates. However, the stock prices of those companies might not begin to reflect those future problems yet, and so the trader may have to wait to establish a short position. However, if the stock price increases to $110 per share and the investor decides to close the short position, he will need to buy-to-cover the 100 shares from the open market at the current price of $110 per share.

72% of retail client accounts lose money when trading CFDs, with this investment provider. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how this product works, and whether you can afford to take the high risk of losing your money. Use the “short” order type on your broker’s order entry system and enter the number of shares you wish to borrow and sell short.

How to Short the Market

Another risk faced by short sellers is a short squeeze, in which a stock with a large short interest (i.e., a stock that has been heavily sold short) climbs rapidly in price. This triggers a steeper price ascent in the stock as more and more short sellers buy back the stock to close out their short positions and cap their losses. Regulators may sometimes impose bans on short sales Shorting a Stock in a specific sector, or even in the broad market, to avoid panic and unwarranted selling pressure. Such actions can cause a sudden spike in stock prices, forcing the short seller to cover short positions at huge losses. If a stock is actively shorted with a high short float and days-to-cover ratio (more on that below), it is also at risk of experiencing a short squeeze.

Shorting a Stock

Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance. Naked shorting has been made illegal except where allowed under limited circumstances by market makers.

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