Short Selling and Why People do it

Generally, people believe that investing involves the buying of an asset, holding on to it until it becomes worth more, and then selling it for a profit. Short selling is the exact opposite: investors make money when shorted securities fall in value. While the concept of short selling might sound complex, it is really quite simple. However, under normal circumstances, only sophisticated investors usually attempt this strategy, due to its high chances of failure.

What is Short Selling?

Short selling involves selling stocks that you do not already own. In order to do this, you will need to set up an account with a broker, and the broker will then lend the stock from either their own inventory, another brokerage firm, or from one of the brokerage firm’s other customers. The shares will be sold and the money will be transferred to your account. The next step is to buy back the same number of stock shares you “borrowed.” The idea is to be able to buy the stock back at a lower price, with the difference in price being your profit.


There are two main reasons people choose to short sell stock, which are for speculation or to hedge funds. Speculation involves carefully watching the market to be able to make a large profit from a high-risk investment. In order to be successful at speculation, calculated assessments of the markets must be made in order to determine when the odds are in your favor. People who use speculation in order to short sell stocks are assuming risk deliberately, and this type of short selling tends to be regarded negatively because it is equated with gambling.


The easiest way to think about hedging is to consider it as insurance. When a seller decides to hedge, it is to insure their assets against a negative event. Hedging investments involve using instruments strategically in order to offset the risk of any negative price movement in the market. Investors use complicated financial tools called derivatives in order to develop trading strategies where a loss in one investment can be offset by a gain in the derivative. Hedging, of course, comes with its own risks; when using this short selling technique, it is important to be sure the benefits justify the cost.

The Risks of Short Selling

When considering short selling, the most important thing to know is that it is a huge gamble. When considering the stock market's history, the trend is upward, despite periodic setbacks. Even companies that barely improve over the years are driven up due to inflation. So, short selling stocks is essentially betting against the general market direction. In addition, when short selling, it is easy to be right at the wrong time. Knowing a company is overvalued is great, but the time it takes for the price to come back down could take awhile, curbing your potential profits.

Short selling is definitely not for everyone. It involves a lot of risk and the ability to study market trends in order to predict what the stock of a company is going to do and move accordingly. Most sellers who short sell are hedge funds, day traders, and wealthy investors who have knowledge about how securities markets work, and specific trading strategies in place.