Shorting Basics

If a stock currently trades at $52 per share and you believe the price has peaked, you may want to short it to profit when the price falls. To do so, you actually borrow shares from your brokerage and sell them. When the price falls to a desired point or rises to the point of your loss threshold, you buy to cover the borrowed shares. If the $52 stock drops to $35 before you buy to cover, you earn $17 per share. If you buy to cover at $54, you lose $2 per share even though the price appreciated.

Margin Requirements

Short Sale Market Risks

You face significant risks as a short seller. When you buy a stock in the traditional manner, you risk losing only the value you invest. When you short, your potential losses are unlimited as the stock price continues to climb. Shorting a stock at $3 leads to huge losses if you buy to cover at $10. Brokerages may also issue a margin call when the stock price rises, which means you must add more funds to cover the margin differential. Brokers may also take liberties in restricting short sale concentrations in one stock.

Additional Short Sale Risks

References

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