WHAT IS
SHORT SELLING?

For many beginner traders, it is assumed that all trading and investing is based on the practice of buying an asset in the hope of selling it later when the price appreciates. However, this is only one narrow part of financial trading (which is typically called going long). 

One widely practised activity that describes the exact opposite of this practice is called short selling. But what is short selling stock, and how does short selling work? In a nutshell, the short selling meaning is one of bearish speculation. It describes any activity in which a trader is taking a position against an asset or security, by betting that it will decline in price. 

If that asset or security does depreciate, then, the short seller makes a profit. It is distinct from the illegal practice of naked short selling, which describes shorting an asset before you have confirmed that it is actually available and exists. In the modern trading world, knowing how to short sell is a crucial skill that can help you diversify your portfolio and take advantage of bearish, pessimistic markets. 

Short Selling for Dummies Explained

Now that you know what short selling means, let’s break down exactly how to short sell. First off, it is worth emphasising that short selling does not involve outright ownership of the asset in question. Rather, it typically involves borrowing the asset from a trading broker.

You then sell it at the current market price with the promise to buy it back later and return it to the lender. If the asset depreciates, you can make a profit as you will keep the difference. However, if the price rises, you will have to buy the asset back and take the loss.

Since there are theoretically no limits on how high an asset price can rise, your losses are technically infinite. Another way to define short selling is speculating on asset prices by buying derivatives, such as CFDs. Again, this does not involve any ownership of the underlying asset itself. 

Short Selling Explained: An Example

 Let’s illustrate this further with a real-world short selling example.

The Benefits of Short Selling Stocks 

There are many benefits to short selling stocks. Namely, they can act as a hedge or a backup against your other investments, such as stocks and bonds. By taking a short position on an asset that you have also invested in, you stand a chance of profiting regardless of which direction that asset’s price moves. Furthermore, although short selling tends to be risky and volatile, it is a way of adding some diversification to your overall portfolio. Although the risks can be high, so can the rewards.

To learn more about opening a short position on eToro, make sure to check out our handy guide on making your first order with us.