Short-selling definition

Short-selling is a trading strategy that investors use when they believe a particular asset’s price will decline in the future. In short-selling, the investor borrows the asset from someone else (usually a broker), and they sell it at the current market price in hopes of buying it back at a lower price at a later date, so they can return the borrowed asset to the lender.

Investors who participate in short-selling are called short-sellers. They aim to make a profit from the difference between the selling price and the buying price.

An example of short-selling

An investor who believes that the stock price of Company ABC will decrease in the coming weeks. They borrow 100 shares of Company ABC from a broker and sell them on the stock exchange for $50 per share, making $5,000 in total.

A few weeks later, the stock price of Company ABC drops to $45 per share. The investor then buys back the 100 shares at this lower price for $4,500 and returns the borrowed shares to the broker. In this scenario, their profit is the difference between the selling price ($5,000) and the buying price ($4,500), which is $500. However, if the stock price had increased instead of decreased, the investor would have occurred a loss.

Advantages of short-selling

Firstly, investors who participate in short-selling are able to find opportunities even in the midst of a market downturn. This is because this trading strategy generates profits when an asset depreciates.

Short-selling can also be used as a hedge against other investments. For example, an investor who has a long position in stock they are worried will depreciate can short-sell the same stock to offset potential losses.

Limitations of short-selling

Short-selling is considered a high-risk investment strategy. This is because when an investor buys an asset, their maximum loss is limited to the amount they invest. However, when an investor short-sells an asset, they run the risk of unlimited potential losses. While the lowest an asset price can reach is $0, there is no limit to how high its price can climb.

If an asset price keeps rising, the short-seller will be forced to buy back the shares at a much higher price than they would have sold them for, resulting in substantial losses.

Start trading with ADSS

ADSS offers a range of global markets for traders, with CFD opportunities in indices, commodities, forex, equities and more. We also feature tutorials, how-to guides, and weekly webinars to help you navigate the financial markets and find better trading opportunities. You can start trading and investing online by opening a live trading or demo trading account.

See all glossary trading terms