what does it mean short a stock
Source: istock

What Does It Mean to Short a Stock?

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Nov. 25 2020, Published 12:40 p.m. ET

Would you bet on who is going to lose while you are watching a sports game? Usually, short-sellers bet that the stock price will fall. The investor doesn’t own the stock during the shorting process. What are the steps for shorting a stock? Can investors make money from short selling stocks?

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Shorting a stock is a bearish stock position. It means that you feel strongly that the stock price is going to decline. Shorting a stock is a popular trading technique for gamblers, speculators, and arbitrageurs. In contrast, long investors bet that the stock price will rise.

shorting a stock
Source: istock
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What does it mean to short a stock?

Shorting a stock means selling a stock that the seller doesn't own. Short selling happens when an investor borrows a stock and sells it on the open market. The seller is willing to buy it back later for a lower price. Short sellers usually bet on and profit from a fall in the stock’s price.

The short-selling aim is to sell high and then buy low. For example, you think a company is overpriced at $100 per share. You borrow 100 shares from your broker and sell them for $10,000. Time ticks on and as you expected, the stock price drops. At $90 per share, you buy 100 shares for $9,000 and return them to your broker. You keep the $1,000 profit.

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What if the stock price rises to $110 per share? At $110 per share, you buy 100 shares for $11,000 and return them to your broker. You generate a loss of $1,000. Short-selling can offer huge gains, but the losses can accumulate quickly and infinitely.

What are the steps for shorting a stock?

You need to follow four steps to short a stock.

  • Borrow the stock that you would like to bet on.
  • Immediately sell the shares you have borrowed.
  • You wait until the stock price declines and then purchase the shares back at the new and lower price.
  • You return the shares to the broker you borrowed them from and keep the profit.
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What Does It Mean To Short A Stock
Source: Unsplash

How long can you short a stock?

There isn't a mandated restriction on how long it's possible to hold a short position. You can hold a short position as long as you are able to meet the margin requirements and pay the required interest.

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Is it legal to short a stock?

Short selling is a legitimate method of stock trading in which an investor bets that the price of a stock is going to decline. During times of financial crisis, when share prices are declining significantly, regulators have weighed in to either restrict or ban the use of short selling temporarily until the order is restored.

Can investors make money from short selling stocks?

Yes, investors can make money from short-selling stocks if an investor feels strongly that the stock price will likely drop in the short term. For example, if a company is facing difficulties and will likely miss debt repayments. If short selling is successful, investors can earn a huge profit in the short term. The stock price falls at a faster rate than it appreciates.

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