Shorting a Stock: A Step-by-Step Guide for Investors

The Federal Reserve Board’s Regulation T defines margin requirements at fifty percent of the trade, while the NYSE requires thirty percent of market value at the time of the trade. One of the most famous short squeezes in history occurred in 2008. German carmaker Porsche owned approximately 31% of Volkswagen in March 2007 and Lower Saxony, a state in Germany, owned 20 percent. The trader is How does forex work rewarded with profits, if the predicted decline occurs. Investors must understand that inverse ETFs are designed to be held and traded during a single trading day.

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Since you initially sold the shares for $10,000, your loss is $4,000, not including any fees or interest accrued during the short position. Your broker will locate shares of the target stock to borrow, typically from other investors’ accounts or the brokerage’s own inventory. The U.S. Securities and Exchange Commission’s (SEC) Regulation SHO requires broker-dealers to have “reasonable grounds” to believe that the security can be borrowed before effecting a short sale in any security.

What is your risk tolerance?

• That year, the SEC adopted an “alternative uptick rule” that restricts short selling when a stock has dropped at least 10% in a day.
• Regulation SHO specifically sought to curb naked short selling—in which the seller doesn’t borrow or arrange to borrow the shorted security—by imposing “locate” and “closeout” requirements for short sales.
• Once you have the correct type of account, along with any necessary permissions, the order details are entered on the order screen just like for any other trade.
• Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.
• They borrow 100 shares of stock in company A from their brokerage and sell the shares for $10 per share for a total of $1,000 (plus any applicable brokerage fees).
• Theoretically, the price of an asset has no upper bound and can climb to infinity.

For example, if Joe is long ABC, he might also hedge his holdings with an equivalent or comparable short in order to cover his losses if the ABC’s price fails to appreciate. While the technique is commonly used to short stocks, it can also be applied to other securities, such as bonds and currencies. George Soros, for example, famously shorted the British pound in the early 1990s, making a $1.5 billion profit in a single month, according to one estimate.

Why Do Investors Sells Stocks Short?

However, because ETFs represent baskets of stocks, they may be less volatile than individual stocks, which often reduces any potential for profit. Certain stocks may be designated as “hard to borrow” because of a lack of supply, regulatory restrictions, or the unwillingness of brokerage firms to lend out the securities. Not all are on board with the changes, including Mark T. Uyeda, an SEC commissioner who has often been critical of the SEC’s actions in recent years. His critique gets at a significant point proponents of short selling make about the practice, namely that short selling is central to price discovery and market efficiency. Setting strict stop-loss limits will often save a short seller. You need to know exactly when you’ll exit a position if it moves against you.

If the price of a shorted security begins to rise rather than fall, the losses can mount up quickly. In fact, since the price of the security has no ceiling, the losses on a short position are theoretically unlimited. Given this inherent riskiness and the complexity of the transaction, shorting securities is generally recommended only for more advanced traders and investors. To set up a short position, traders generally borrow shares of the security from their brokerage. This means that going short requires a margin account, as well as other potential permissions and possible broker fees.

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• Short positions represent borrowed shares that have been sold in anticipation of buying them back in the future.
• However, when someone shorts a stock, they risk infinite losses because there is no upward limit on a stock’s share price.
• A SoFi Invest online brokerage account lets investors trade an array of stocks, ETFs or fractional shares.
• This strategy is popular among savvy, risk-tolerant investors with a knack for market research and predicting trends.
• As you can see above, the short squeeze then began in earnest in January 2021.
• You are now leaving the SoFi website and entering a third-party website.

Is Shorting a Stock Wrong?

The Federal Reserve Board’s Regulation T defines margin requirements at fifty percent of the trade while the NYSE requires thirty percent of market value at the time of the trade. In such instances, the trader is obligated to return the stock by purchasing it in the open market at the prevailing price. A variation of short selling is naked selling in which the trader sells shares without borrowing them first. A short squeeze refers to the rapid flight of short sellers from a stock in order to limit losses — a situation that leads to a dramatic surge in the stock’s price.

In recent times, however, the effect of short selling on investment markets has been tamped down due to the rise of passive investing. Short squeezes occur when a trader purchases a large block of shares to finish a short position. The purchase could result in artificial demand for a company’s shares and result in a temporary price bump for the security. Short selling, also known as shorting a stock, is a trading technique in which a trader attempts to generate profits by predicting a stock’s price decline. When a share starts gaining, instead of falling, that’s trouble for the short seller.

In October 2024, the Bank of England warned that the size of hedge funds’ short positions against U.S. Treasury futures had grown to almost $1 trillion, a figure so large it could upend the financial system should the positions need to be unwound. But it’s not just individual traders who can be devastated by short selling losses.

Kept for longer, inverse ETFs may not achieve the exact -1x return of the underlying index. For example, imagine that an investor wants to short a stock that we’ll call ABC company. The investor believes the company is overvalued and the stock will soon head to $8 or lower. Short selling goes against the entrenched upward trend of the markets. Most investors and other market participants are long-only, creating natural momentum in one direction. Hedge funds were the target of the 2021 and 2024 GameStop short squeezes.