Short (sale, position)

When an investor borrow stock from a brokerage to sell on the market, it is known as a short sale. The investor does not own the shares he sold and therefore “owes” the shares to the broker. He receives cash from the short sale and a certain amount must be maintained in his margin account to maintain the short position.

Suppose an investor shorts 100 shares of XYZ at $50/share. He will receive $5000 and will “owe” the brokerage 100 shares of XYZ. If XYZ falls to $40/share, the investor can buy the shares back from the market for $4000 ($40 X 100) and return them to the brokerage. He will have netted $1000 in the trade.

An investor/trader sells a stock short when he believes it will fall in price. However, it may also be done to establish a hedge. See “Pair trade” for more.

Short selling is widely perceived by individual investors to be risky. Because the lowest a stock’s price can fall is 0 and your maximum risk for loss is 100% if you aren’t leveraged. But an investor can lose an unlimited amount of money selling short because a stock can in theory, rise to infinity. However, this is not quite true, as margin restrictions would force the investor to cover his short position if the losses are too high.

An investor can only sell short in a margin account.

There may be restrictions on what kind of stocks can be shorted. Stocks with low liquidity and that are hard to borrow may not be available for the individual investor to short. Also, in times of distress, the SEC may place a limit on who can short, such as in 2008.

In the futures and derivatives markets, for each long position there is a corresponding short position.

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