What Does it Mean to “Short” a Stock?

What does it mean to "short" a stock? It is risky.When watching a sports game, would you bet on who’s going to lose?

That’s essentially what “short-sellers” do: they bet that a stock, sector or broader benchmark will fall in price. (“Long investors” bet that prices will rise.)

Here’s a simplified example of how shorting works:

Say you think Company ABC is overpriced at $50 a share. You borrow 100 shares from your broker—pay interest on the loan—and sell them for $5,000. Time ticks on, and as you suspected, the stock price falls. At $40 a share, you buy 100 shares for $4,000 and return them to your broker. You walk away $1,000 richer, minus investing costs.

That’s a successful short. But what if the stock gains in popularity? Say the price rises to $60 a share, or $6,000 for those 100 shares you need to return. You’re out $1,000.

Shorting, in short, is a strange transaction. You’re selling something you don’t own. And the goal is to sell high and then buy low, says Ryan Bend, co-portfolio manager of the Federated Prudent Bear Fund (BEARX), as opposed to the common game plan of first buying low then selling high.

Companies—and ultimately governments—get cranky when lots of folks bet on a downfall. Struggling Greece, for example, actually banned short-selling temporarily.

You probably don’t need to be dancing around in your undies to know that this is, um, Risky Business, and not right for most individual investors.

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2 Responses to “What Does it Mean to “Short” a Stock?”

  1. jelly green

    why would the broker who sold the borrowed stock for $50.00 want to buy it
    back for $40.00

    • bOgGaRt

      You don’t do transactions with money but with stocks. How it works is, you borrow 100 shares and you pay back 100 shares. You take the risk and the broker gets the interest.