Written by Short Selling in Stocks: What It Is and How It Works
What Is Short Selling?
- Definition: Short selling involves borrowing shares of a stock and selling them, with the expectation that the stock’s price will decrease. The shares are later repurchased at a lower price to return to the lender.
- How It Works: If the stock price falls after the short sale, the investor buys back the shares at a lower price and pockets the difference. If the price rises, the investor incurs a loss.
When and Why to Short Sell
- Bearish Outlook: Short selling is often used when an investor believes the stock’s price will decline.
- Hedging: Investors may use short selling as a way to hedge against other positions in their portfolio.
- Speculation: Some investors short sell to speculate on stock price movements, hoping to profit from declines.
Risks and Considerations
- Unlimited Losses: Unlike buying stocks, where losses are limited to the amount invested, short selling has the potential for unlimited losses if the stock price rises significantly.
- Margin Requirements: Short selling typically requires a margin account, where the investor must maintain a minimum balance to cover potential losses.
- Short Squeeze: If a large number of investors short a stock and the price starts rising unexpectedly, it can lead to a short squeeze, causing rapid losses for short sellers.
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