Short Selling
Short selling is an investment strategy where an investor borrows shares to sell immediately, hoping to buy them back later at a lower price and profit from the decline.
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Exam Tip
Short selling = UNLIMITED loss potential (stock can rise forever). Must use margin account.
What is Short Selling?
Short selling is betting that a stock will go down. You borrow shares from your broker, sell them, and hope to buy them back later at a lower price. The difference is your profit.
How Short Selling Works
- Borrow shares from broker
- Sell borrowed shares at current price
- Wait for price to drop
- Buy shares back at lower price
- Return shares to broker
- Keep the difference as profit
Example
| Step | Action | Price | Amount |
|---|---|---|---|
| 1 | Borrow and sell 100 shares | $50 | Receive $5,000 |
| 2 | Stock falls, buy back 100 shares | $30 | Pay $3,000 |
| 3 | Return shares, keep profit | ā | Profit: $2,000 |
Risks of Short Selling
| Risk | Description |
|---|---|
| Unlimited Loss | Stock can rise infinitely |
| Margin Requirements | Must maintain margin |
| Short Squeeze | Rapid price rise forces covering |
| Borrowing Costs | Fee to borrow shares |
| Dividends | Must pay dividends to lender |
Short Squeeze
When a heavily shorted stock rises rapidly, short sellers rush to buy shares to cover their positions, driving the price even higher.
Regulations
- Uptick Rule (modified) - Restrictions when stock drops 10%+
- Reg SHO - Requires locate before shorting
- Must be done in margin account
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