Trading Defined
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Short Selling

Short selling means selling something you have borrowed, hoping to buy it back later for less and keep the difference.

Most people make money in markets by buying first and selling later at a higher price. Short selling reverses the order: you sell first, using an asset you have borrowed, and buy it back later. If the price has fallen in the meantime, you keep the difference. If it has risen, you lose — and unlike an ordinary purchase, there is no natural ceiling on how much.

Category
Trading Basics
Reading time
12 min
Also called
Shorting, Short position, Going short
Updated

Short selling in plain words

Imagine a friend lends you a concert ticket that is currently selling for $100. You think the price will drop, so you sell the ticket today for $100. A week later the same ticket costs $70. You buy one, give it back to your friend, and keep the $30 difference.

That is the whole idea. In the stock market, your broker plays the role of the friend: it arranges for you to borrow shares, you sell them, and later you must buy the same number of shares back and return them. Your result depends on one question — did the price go down or up while you were holding the borrowed shares?

The opposite approach, buying an asset because you expect it to rise, is called a long position. Short selling is how traders try to profit when they expect a price to fall.

How short selling works, step by step

Here is the full life of a short sale of shares through a broker. Short positions in futures, CFDs or crypto derivatives skip the borrowing step, but the profit and loss work the same way.

  1. You form a view that the price will fall

    Short selling only makes sense if you believe an asset is overvalued or about to decline — for example after weak earnings, a broken trend on the price chart, or a business problem you think the market has not priced in yet.

  2. Your broker locates shares for you to borrow

    You need a margin account, because a short sale is a loan. The broker finds shares to lend you, usually from its own inventory, from other clients' margin accounts, or from another lender.1 In the US, the broker must have borrowed the shares, arranged to borrow them, or have reasonable grounds to believe they can be borrowed before the short sale goes through.2

  3. You sell the borrowed shares at today's price

    The shares are sold in the market just like any other sale. The cash from the sale lands in your account, but it is not free money: it is held as collateral, and the broker will usually require you to post extra margin on top of it.

  4. You hold the short position and pay to borrow

    While the position is open you pay a borrowing fee, usually quoted as an annual percentage and charged daily. If the company pays a dividend, you owe the lender an equal amount.1 Your losses grow every time the price rises.

  5. The price moves — down, you hope

    If the price falls, your position gains value. If it rises, the broker may ask for more collateral (a margin call). If you cannot provide it, the broker can close your position for you at whatever the current price is.3

  6. You buy the shares back (“buy to cover”)

    To close the trade you buy the same number of shares you borrowed. This purchase is called buying to cover. Many traders decide in advance at which price they will do this if they are wrong, using a stop-loss order.

  7. The shares are returned and the result is settled

    The repurchased shares go back to the lender. Your gross profit is the sale price minus the repurchase price, multiplied by the number of shares. Your net profit is what is left after borrowing fees, dividend payments, commissions and any margin interest.

Figure 1

The short-sale cycle

The short-sale cycle as a sequence of transfersOn day 1 the lender lends you 10 shares, you sell them in the market at $100 and receive $1,000. Thirty days later you pay a $2.47 borrowing fee, pay $700 to buy 10 shares back at $70, and return the shares to the lender. Net result: $297.53.LenderYouMarketDAY 1 — OPENDAY 30 — CLOSElends 10 sharessells 10 @ $100+$1,000 cashfee −$2.47pays −$70010 shares @ $70returns 10 sharesNet result: $1,000 − $700 − $2.47 = +$297.53sharescash
Shares travel from the lender to the market, then back from the market to the lender. Cash goes the other way. Your profit or loss is the gap between the two cash flows.

Worked examples

Example 1 — The price falls as expected

Profit

You short 10 shares of a company at $100. Thirty days later the shares trade at $70, and you buy them back.

Assumptions
  • Borrowing fee of 3% per year, charged on the $1,000 sale value for 30 days.
  • A commission-free broker and no dividend paid during the 30 days.
Example 1 — The price falls as expected — calculation
Sell 10 borrowed shares at $100+$1,000.00
Buy back 10 shares at $70−$700.00
Gross profit ($30 × 10 shares)+$300.00
Borrowing fee ($1,000 × 3% × 30 ÷ 365)−$2.47
Net profit+$297.53

The price fell by $30 per share, so the gross profit is $30 per share or $300 in total. Costs are small here because the fee was low and the trade was short-lived. For hard-to-borrow stocks, annual fees can reach double or even triple digits, which changes the picture completely.

Example 2 — The price rises instead

Loss

Same trade, but the shares rise to $130 and you decide to cut the loss after 30 days.

Assumptions
  • Same 3% annual borrowing fee and no commissions.
Example 2 — The price rises instead — calculation
Sell 10 borrowed shares at $100+$1,000.00
Buy back 10 shares at $130−$1,300.00
Gross loss ($30 × 10 shares)−$300.00
Borrowing fee−$2.47
Net loss−$302.47

A $30 move against you costs exactly as much as a $30 move in your favour would have earned. The costs do not disappear when you lose: the fee is added to the loss.

Example 3 — Why the loss has no ceiling

Loss

Now suppose surprising news sends the shares from $100 to $250 before you close the position.

Example 3 — Why the loss has no ceiling — calculation
Sell 10 borrowed shares at $100+$1,000.00
Buy back 10 shares at $250−$2,500.00
Gross loss−$1,500.00
Loss as a share of the original sale value150%

When you buy a share for $100, the most you can lose is $100, because a price cannot fall below zero. When you short a share at $100, the most you can make is $100 (if it goes to zero), but the price can keep climbing, so the loss is theoretically unlimited.4 In practice the broker will usually force you out with a margin call long before this — often at the worst possible moment.

Figure 2

Profit and loss of a short position when you close it

Profit and loss of a short position: 10 shares sold short at $100A straight line falling from a profit of $1,000 at a price of $0, through zero at $100, to a loss of $1,000 at $200 and continuing. At $70 the profit is $300; at $130 the loss is $300.PROFIT ↑LOSS ↓−$1,000−$500+$500+$1,000$0$0$50$100$150$200Share price when you close the positionEntry $100break-even before costs$70 → +$300$130 → −$300Max profit +$1,000if the price falls to $0no limit on the loss ↘
Short 10 shares at $100, before costs. Every dollar the price falls adds $10 of profit; every dollar it rises adds $10 of loss. Profit is capped at $1,000 (price at zero); the loss line keeps going.

Try it: short-sale calculator

Change the numbers to see how the repurchase price, holding period and borrowing fee affect your result. Nothing is sent anywhere — the calculation happens in your browser.

Calculated result
Gross result: (sell − buy back) × shares+$300.00
Borrowing fee−$2.47
Commissions (open + close)$0.00
Net result+$297.53

That is +29.8% of the sale value ($1,000.00). Break-even after costs: $99.75 — buy back below this to make a profit.

Simplified: ignores taxes, spreads, slippage, dividends owed to the lender and margin interest.

Short selling vs. long position

The two positions are mirror images, but the risks are not symmetrical.

AspectShort positionLong position
You expect the price toFallRise
Order of tradesSell first, buy back laterBuy first, sell later
Maximum profitThe sale price (if the price drops to zero), minus costsUnlimited in theory
Maximum lossUnlimited in theoryThe amount invested (without leverage)
Ongoing costsBorrowing fee, dividends owed to lender, margin interestNone if bought with your own cash
Account neededMargin account (for shares)Ordinary cash account is enough

Why traders short sell

  • To profit from a decline

    A trader who believes a company is overvalued, or that a market is about to turn down, can express that view directly instead of simply staying out.

  • To hedge an existing position

    A fund that owns many bank stocks might short a banking index to reduce its exposure to a sector-wide drop, while keeping the individual stocks it likes. Gains on the short offset part of the losses on the longs.1

  • To trade relative value

    In a pairs trade, a trader goes long one company and short a similar one, aiming to profit from the gap between them rather than from the direction of the whole market.

  • To provide liquidity and price discovery

    Market makers routinely sell short to fill buy orders when demand arrives unexpectedly.1 More broadly, short sellers add selling pressure to overpriced assets, which can help prices reflect negative information sooner.

Advantages and disadvantages

Advantages

  • Lets you profit, or protect a portfolio, when prices fall — not only when they rise.
  • Useful as a hedge that reduces risk without selling positions you want to keep.
  • Can be applied across many markets: shares, ETFs, futures, currencies and crypto derivatives.

Disadvantages

  • Losses are theoretically unlimited, because there is no upper limit to a price.4
  • You pay to hold the position: borrowing fees, dividends owed to the lender and margin interest.1
  • Margin calls can force you to close at a bad price, even if your view later proves right.
  • Heavily shorted assets are prone to a short squeeze, where rising prices force short sellers to buy, pushing prices higher still.
  • The lender can recall the shares, which can force you to close earlier than planned.

Going deeper

Read as far as you need. Each level builds on the one before it.

What you must know before your first short

Beginner

Short selling uses borrowed assets, so it always involves a loan and a margin account. The maximum gain is limited; the maximum loss is not. Always decide where you will buy back if you are wrong before you open the trade, and size the position so that this loss is affordable.

Margin, collateral and margin calls

Intermediate

In the US, Federal Reserve Regulation T generally requires a short seller to deposit 50% of the short sale's value as additional margin, on top of keeping the sale proceeds in the account — 150% of the position value in total.5 Brokers then require you to keep a minimum level of equity (the maintenance margin). Many set it higher than the regulatory minimum, and they can raise it at any time without advance notice.3

Because the value of a short position grows as the price rises, a rising price eats into your equity from both sides: the liability grows while the collateral stays fixed. That is why a short can trigger a margin call quickly. See margin and liquidation.

Borrow availability, rules and synthetic shorts

Advanced

Borrowing fees are set by supply and demand for lendable shares. When many traders want to short a stock with few lendable shares, it becomes hard to borrow, fees rise sharply and recalls become more likely. Selling short without having borrowed or located the shares (naked short selling) is generally prohibited in the US under Regulation SHO.2

In the US, SEC Rule 201 (the alternative uptick rule) restricts short sales in a stock whose price has fallen 10% or more from the previous close: for the rest of that day and the following day, short sales are generally only allowed above the current national best bid.67

Traders can also take short exposure without borrowing anything, by selling futures, buying put options, using CFDs where they are legal, or opening a short in crypto perpetual futures. The payoff resembles a short sale, but the costs and risks differ — for example funding rates in perpetual futures, or the premium paid for a put option, which is the most an option buyer can lose.8

Common mistakes

  1. Treating a short like a mirror-image long

    The price chart may look symmetrical, but the risk is not. A long can lose at most 100% of what you paid; a short can lose more than 100% of what you received.

  2. Ignoring the cost of carry

    Borrowing fees, dividend payments and margin interest accumulate every day. A short that is right in direction but slow in timing can still lose money.

  3. Shorting just because a price “looks too high”

    Expensive assets can become much more expensive. Overvaluation alone says nothing about when a price will fall, and a short seller pays for every day of waiting.

  4. Running without a stop or a size limit

    Without a predefined exit, a sudden spike can wipe out months of gains in a single session. Use a stop loss and size the position with position sizing, remembering that stops can be filled at a worse price when markets gap.

  5. Crowding into popular shorts

    When a large share of a company's free float is sold short, a small piece of good news can trigger a short squeeze. Check how crowded a trade is before joining it.

Check your understanding

Test yourself before moving on. Each answer comes with an explanation.

Q1You short 20 shares at $50 and buy them back at $42. Ignoring costs, what is your result?
Q2Why is the maximum loss on a short position called “unlimited”?

Key points to remember

  1. Short selling is selling a borrowed asset now and buying it back later, aiming to profit from a fall in price.
  2. Gross profit = (sale price − repurchase price) × quantity. Net profit also subtracts borrowing fees, dividends owed, commissions and interest.
  3. The maximum profit is limited to the sale value; the maximum loss is theoretically unlimited.
  4. Short positions on shares require a margin account, and rising prices can trigger margin calls and forced closure.
  5. Always plan the exit and the position size before opening a short.

Frequently asked questions

Is short selling legal?

Yes. Short selling is legal and regulated in most major markets. Regulators can temporarily restrict it: the SEC barred short sales of financial stocks in September 2008,9 and several European regulators imposed temporary bans in March 2020.10 Some forms, such as naked short selling, are generally prohibited.2

Who lends the shares to short sellers, and why?

Shares are usually lent by brokers from their own inventory or from clients' margin accounts, or by other lenders such as large institutional holders.1 Lenders earn the borrowing fee, which is extra income on shares they intend to hold anyway.

How long can I keep a short position open?

There is usually no fixed limit for shorting shares. You can hold the position as long as you meet margin requirements and the lender does not recall the shares — but you pay the borrowing fee for every day it stays open.

What happens if the company pays a dividend while I am short?

The lender is still entitled to it, so you must pay an amount equal to the dividend. This is often called a payment in lieu of dividends, and it is a real cost of the trade.1

Can I short sell in a regular cash account?

Not when shorting shares directly — it requires borrowing, so you need a margin account.4 Some investors get short exposure in other ways, such as buying put options or an inverse ETF, which have different risks of their own.

Is short selling the same as betting a company will fail?

Not necessarily. Most short sellers simply expect a price to be lower in the future than it is today. That can happen to a perfectly healthy company whose shares became too expensive, or as part of a hedge that has nothing to do with the company itself.

Further learning

  • Long Position

    The mirror image of a short position — understand both to see why their risks differ.

  • Trading Chart

    Most traders time short entries and exits on a price chart. Learn to read one first.

  • Margin

    Every share short is a margin loan. Margin explains collateral and margin calls.

  • Short Squeeze

    The specific danger of crowded short positions.

Sources

This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.

  1. Investor.gov (SEC). Stock Purchases and Sales: Long and Short (opens in a new tab) Checked .
  2. U.S. Securities and Exchange Commission. Key Points About Regulation SHO (opens in a new tab) Checked .
  3. FINRA. Know What Triggers a Margin Call (opens in a new tab) Checked .
  4. Investor.gov (SEC). Investor Bulletin: An Introduction to Short Sales (opens in a new tab) Checked .
  5. Legal Information Institute, Cornell Law School. 12 CFR § 220.12 – Supplement: margin requirements (Regulation T) (opens in a new tab) Checked .
  6. U.S. Securities and Exchange Commission. Responses to Frequently Asked Questions Concerning Rule 201 of Regulation SHO (opens in a new tab) Checked .
  7. U.S. Securities and Exchange Commission. SEC Approves Short Selling Restrictions (press release 2010-26) (opens in a new tab) Checked .
  8. Investor.gov (SEC). An Introduction to Options – Investor Bulletin (opens in a new tab) Checked .
  9. U.S. Securities and Exchange Commission. SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets (press release 2008-211) (opens in a new tab) Checked .
  10. European Securities and Markets Authority. Non-renewal and termination of short selling bans (May 2020) (opens in a new tab) Checked .

Read more elsewhere

Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.