But, with short selling, the exact opposite is true. When you buy a stock, your upside is unlimited, while the maximum you can lose is all of your investment or 100% (in the event that stock price falls to $0). And the risk of guessing wrong is higher with short selling than with traditional investing. The big risk of short selling is that you could guess wrong and stock may go up. At $37 per share, you decide that ABC is on the comeback trail and exit your short position to lock in profits and avoid eating into the eventual profits of your long position (in which you benefit from ABC's appreciation). We'll assume that ABC drops all the way to $35 per share before beginning to rebound. However, the profits from your short sale are able to negate those losses. Once the stock's value drops below $40, your long position begins to lose money. In this case, you may decide to short 200 shares of ABC at $40. You don't want to sell, but you're also worried about the company's short-term prospects due to a negative news event, a disappointing earnings report, or some other reason. For example, let's say you're an investor in ABC stock: You own 200 shares at an average price of $40 per share. 20 = $5,000).Ī trader may also decide to go short on a stock in order to hedge against a long position (that is, shares they already own outright). In this case, the trader's profit is actually 20% since only $25,000 of capital was put at risk ($25,000 x. Now suppose the underlying stock depreciates by 10% to $45,000 before the position is closed for a $5,000 profit. The use of margin in short selling is also attractive to many traders, as it means lower capital requirements and the potential for high profit margins.įor example, a trader with $25,000 in a margin account may be able to take a short position of up to $50,000. Traders primarily participate in short selling - or going short, in traders' lingo - as a means of profiting on short-term declines in a stock's value. What's the advantage of short selling stock? But if the price goes up, the trader may be forced to close the position at a loss. If the share price goes down, the short-seller can buy them back at the lower price, return them to the lender, and pocket the difference for a nice profit. Regardless of how a shorted position performs, the borrowed shares must eventually be returned to the lender. These costs will decrease the short-seller's overall profit or exacerbate their losses. And if any dividends are paid out while the shares are on loan, the short-seller must pay for them as well. Margin interest must be paid on the shorted shares until they're returned to the lender. The broker may lend from their own inventory, another broker's inventory, or from clients who have margin accounts and are willing to lend their shares. Generally, short-sellers borrow the shares from their broker. Short selling, aka shorting or taking a short position, is when traders or investors sell stocks they've borrowed in hopes of buying them back later for less money. But are the potential benefits of short selling worth the risks? Here's what you need to know. While hedge fund managers and professional traders are the most prominent players in the short-selling arena, any investor with a margin account can go short on a stock.
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