What is a short sale?
Short answer
In a short sale, a trader borrows shares, sells them, and later buys them back to return to the lender. The trader gains if the price falls and loses if it rises, and potential losses have no fixed upper limit.
How it works
A trader borrows shares through a broker, sells them at today’s price, and hopes to buy the same number back later at a lower price. The shares bought back are returned to the lender and the trader keeps the difference, minus costs such as borrow fees and interest on the margin account.
Illustrative arithmetic: shorting 100 shares at 50 and buying them back at 40 gives a gross gain of (50 - 40) x 100 = 1,000. If the price rose to 70 instead, the gross loss is (70 - 50) x 100 = 2,000.
Gross profit = (sale price - buy-back price) x number of sharesWhy the risk is different
A buyer of a share can lose at most the amount paid. A share price can rise without a ceiling, so a short seller’s loss can exceed the original sale proceeds. Brokers require margin and can demand more money or close the position. A short squeeze occurs when rising prices force short sellers to buy back, which pushes the price up further.
Rules and purposes
Short selling is regulated and rules differ by country. Regulators have at times restricted it in stressed markets, and some markets limit or ban uncovered ("naked") short selling. Supporters say short sellers add liquidity and help correct overpriced shares; critics worry about added volatility. Funds also use short positions to hedge other holdings.