If you’re familiarizing yourself with investing, you may have come across the term “short selling.” Short selling can be a great way to make money, but there are some important things you should understand if and when you should ever decide to short sell stocks. So let’s go over the basics!
Most of the time when you invest, you want the price of the stock you invest in to go up. When you short sell, however, you want the price of the stock to go down. When you short sell a stock, you essentially borrow the stock from a broker and sell it. When the price of the stock goes down, you will then buy the stock at a lower price and repay the broker the stocks sold.
So, basically, you borrow an asset you don’t own, say shares of Ford Motor Company, and sell it because you believe that stock prices will drop. Investing is all about buying low and selling high and that’s exactly what you are doing when you short sell. You are selling high with the anticipation of being able to buy low in the future.
Sometimes investors come to believe that a stock’s price will drop. If you believe that the stock of a certain company will decline in price, short selling can be a great way to make money. However, there are some special risks associated with it. You should consider these risks closely.
Most of the time when you invest in stocks, your risks are limited to the amount of money you invest. So if you invest $1,000 dollars in General Motors stocks, even if the company goes bankrupt, you will lose at most $1,000 dollars. If you short sell stocks, however, and the total value of the stocks rise to $10,000 dollars, you will end up owing more than $1,000 dollars because you will have to spend $10,000 to repay the broker.
Predicting when prices will fall can be as difficult as predicting when prices will rise, so short selling can be a high-risk strategy without necessarily offering more potential to produce profits.