When most investors put money in the stock market, they go “long”. That is, they buy shares in the hope that the price will go up. Short selling is the opposite of this – it’s a method of profiting from a share price going down.
Here’s how it works: a short seller borrows the shares from someone who already owns them (usually a fund manager) – the fund manager is happy to lend the shares to the short seller, because they get a fee in return for the loan. The short seller then sells these shares in the open market. If things go according to plan, the share price falls and the short seller can then buy the shares back at the lower price, return them to the lender, and pocket the profit.
So, for example, say you want to bet that the share price of Dodgy Widgets plc is heading for a fall. You borrow 10,000 shares from a friendly fund manager, and sell them at £1 a share. So you now have £10,000, but you owe the fund manager 10,000 shares. Thankfully, Dodgy Widgets issues a profit warning later that month, and the share price falls to 80p per share as a result. You buy 10,000 shares back for £8,000. You return the shares, and keep your £2,000 profit (less your borrowing fee).
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Professional short sellers try to hunt down companies with weak business models, and bet against them. Managements don’t like being challenged in this way, so short sellers are often maligned. But in fact they provide a valuable service, and sometimes help to reveal the truth about an overhyped or downright fraudulent company.
Shorting is also far riskier than being “long”. If you buy a share, then the worst that can happen is that the share price goes to zero, and you lose all of the money you invested. But with short selling your losses are technically unlimited, as there is no ceiling on how high a share price can rise.
In our previous example, if Dodgy Widgets hadn’t warned on profits, but instead said that it was set to make much more money than expected, sending the share price higher, then our short-seller would still have to buy the shares back in order to return them. In this case, they would be looking at a hefty loss.
To learn more about short-selling, subscribe to MoneyWeek magazine.
-
Tycoon Truong My Lan on death row over world’s biggest bank fraudProperty tycoon Truong My Lan has been found guilty of a corruption scandal that dwarfs Malaysia’s 1MDB fraud and Sam Bankman-Fried’s crypto scam
-
Why undersea cables are under threat – and how to protect themUndersea cables power the internet and are vital to modern economies. They are now vulnerable
-
What is a dividend yield?Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
-
High earners to pay nearly £2000 more in tax due to fiscal dragVideos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
-
What is a deficit?Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
-
Too embarrassed to ask: what is moral hazard?Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
-
Too embarrassed to ask: what is contagion?Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
-
Too embarrassed to ask: what is a marginal tax rate?Videos Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
-
Too embarrassed to ask: what is stagflation?Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
-
Too embarrassed to ask: what is the metaverse?Videos The term “metaverse” sounds like something out of a science fiction novel (and it is). But what does it actually mean?
