How Short Selling Works

• Short selling, also known as shorting, is a trading strategy where an investor sells a security today and buys it back in the future, hoping the price will go down.

• This strategy is the opposite of a traditional long position, where investors buy today and sell later, hoping the price will go up.

• Shorting involves borrowing a security from a broker and selling it, then buying it back later to return to the broker.

• Investors who short sell need to post an initial margin, typically 50% of the value of the borrowed security, to cover potential losses.

• Shorting amplifies returns, both positive and negative, due to the use of leverage.

• Short selling comes with unique costs, such as interest on the borrowed security and dividend payments.

• Short positions face buy-in risk, where a broker may force the investor to cover their position prematurely.

• Short positions also face short squeeze risk, where a surge in demand for the shorted stock can lead to significant losses.

• The biggest risk with short positions is their skewed payoff, where potential losses are unlimited while potential gains are capped.

• Due to the high risks involved, many investors prefer to stick with long positions.