What is short selling and how do you short a stock?
A short sale is the sale of a stock that an investor does not own or a sale which is consummated by the delivery of a stock borrowed by, or Shorting a Stock for the account of, the investor. Short sales are normally settled by the delivery of a security borrowed by or on behalf of the investor.
Why is it called selling short?
A short position is one that bets against the market, profiting when prices decline. To sell short is to take such a bet. This is opposed to a long position, which involves buying an asset in hopes that the price will rise.
This method of betting against the stock market can be lucrative but has big risks. Shares that are difficult to borrow—because of high short interest, limited float, or any other reason—have “hard-to-borrow” fees that can be quite substantial. The fee is based on an annualized rate that can range from a small fraction of a percent to more than 100% of the value of the short trade and is prorated for the number of days that the short trade is open. In this case, you will sell the 50 shares for $30, meaning that you will have $1,500. This means that you will have to pay $500 more from your pocket. Silvergate stock is currently down about 88% from one year ago, with a share price of $17.27. There’s no denying that 2022 was one of the most dynamic years in the stock market.
Individual investors often avoid this strategy because it involves many practical headaches. For example, the brokerage firm must approve the account for short sales. Then the position requires establishing an initial margin deposit and a readiness to shore it up whenever necessary.
Another risk is that a short squeeze occurs, this happens when the market rallies and short-sellers need to exit their positions quickly. Squeezes are a chain reaction, so as more shorters close their positions, the price is driven higher, causing even more traders to sell. If your initial prediction was correct and the stock fell in value, you could close your position and profit from the difference between your sell and buy prices. But, if the market had increased instead, you’d have to buy back the shares at a higher price and pay the difference – ultimately generating a loss. When you short sell with derivatives – such as CFDs and spread bets – you won’t need to borrow the shares before you take your position, as you’re just speculating on the underlying market price. You’d just need an account with a derivatives provider, and you could open a short position simply by selecting ‘sell’ in the platform.
The investor buys back the shares, closes out the position, and returns the shares to their broker-dealer. The total cost of the closing transaction is $30,000 (500 shares x $60 per share).
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If a stock is actively shorted with a high short float and days-to-cover ratio , it is also at risk of experiencing a short squeeze. A short squeeze happens when a stock begins to rise, and short sellers cover their trades by buying their short positions back. Demand for the shares attracts more buyers, which pushes the stock higher, causing even more short sellers to buy back or cover their positions. When you trade stocks in the traditional way (“buy low and sell high”), the maximum amount that you can lose is your initial investment. However, when short selling stocks, your losses are theoretically unlimited, since the higher the stock price goes, the more you could lose. You will be charged interest only on the shares you borrow, and you can short the shares as long as you meet the minimum margin requirement for the security. Review the short selling example below to see how short selling a stock works.