Few things in the finance world are as confusing as shorting a stock. You may not have even ever heard of "shorting," but it can be an important component of your investment portfolio, so let's look a little closer.

What is Shorting a Stock?

Shorting is essentially selling a stock before you buy it. You borrow the stock and sell it, so now you have to buy it back at some point in the future. One prime reason you might do this is if you thought a stock was going to do poorly and wanted to profit from that belief. You'd buy the stock at the current price and then after it plummeted, you'd buy it back and pocket the difference.

For example, let's suppose that I think Apple is going to do very poorly in the near future. I might short 100 shares of Apple at $333 per share. I would suddenly have $33,300 in my account which sounds good, but I also owe 100 shares of Apple. If the stock goes down $25 per share, I could buy it back at $308 and I'd pocked $2,500. If it goes up $25 per share, however, then I lose $2,500.

What About the Broker?

Why does your broker loan you the stock? Well for one thing, because they get to charge you a commission. Many brokers also charge you other fees for loaning you the stock, so be sure to check out what fees or margin costs are associated with shorting a stock at your brokerage.

When Would I Short?

The most obvious reason to short a stock is because you have a strong belief it's going to go down. We'll also talk about hedging, in which you might short a stock to offset risk from another stock in your portfolio.

The biggest reason not to short is because historically the stock market goes up. Inflation combined with the general forward progress of society have historically made betting against the stock market dangerous. Of course at the right time it can be a great move.

Photo Source

retirebyforty's picture

retirebyforty wrote:

Sat, 01/08/2011 - 16:09 Comment #: 1

Shorting is too tricky for me, it just feels so speculative.

Financial Ramblings « Intelligent Speculator's picture

Financial Ramblings « Intelligent Speculator wrote:

Sun, 01/09/2011 - 04:42 Comment #: 2

[...] publish VIX like indexes for individual stocks @ Vix and more -2011: What to watch @ BalanceJunkie -What is shorting? @ Momvesting -2010 Goals reviewed and 2011 Financial Goals @ TheFinancialBlogger -Book review: The [...]

Christa Palm's picture

Christa Palm wrote:

Wed, 01/12/2011 - 15:16 Comment #: 3

Retirebyforty, I'm not too keen on shorting stocks either: It seems like no one ever drops lucrative stock tips in my lap...But, see our post on hedging to get a sense of how shorting may be better used to your benefit :)

Jacob @ My Personal Finance Journey's picture

Jacob @ My Personal Finance Journey wrote:

Mon, 01/17/2011 - 02:46 Comment #: 4

Shorting, to me, also seems too risky! I don't dedicate enough time to studying the movements of stocks to be able to use it safely I think.

Christa Palm's picture

Christa Palm wrote:

Mon, 01/17/2011 - 19:28 Comment #: 5

Jacob, welcome, and thanks for the comment! Check out our hedging article for a way to short a stock as insurance :)

 Festival of Stocks, March 21, 2011's picture

Festival of Stocks, March 21, 2011 wrote:

Mon, 03/21/2011 - 14:11 Comment #: 6

[...] presents Shorting posted at [...]

Financial Definitions - Glossary for Understanding Finances 's picture

Financial Definitions - Glossary for Understanding Finances wrote:

Thu, 01/19/2012 - 21:47 Comment #: 7

[...] S Short Sale Specialty Funds Stocks, Chart Patterns Stocks, Global Stocks Stocks, Indices Stock Orders Stocks, Shorting [...]