When watching a sports game, would you bet on who’s going to lose?
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.