Short Selling Stocks: Pros and Cons of the Investment Process

Written by 
Tommy Syrmolotov
December 22, 2021

Answer: Samsung

Hover your cursor over the buildings and look at the connections between the companies

shorting stocks downward graph - photo

Short selling in the stock market works on the assumption that the stock they short sell will decline in price. The theory and process are straightforward. Investors “borrow” a stock to sell it in the market at the current high prices. When prices fall, the trader repurchases it cheaper, and the repurchased stock is returned to the lender. The difference in prices between bought and sold stock is the trader’s profit.

Download Gainy to find stocks that match your portfolio and goals

Try GainyTry Gainy

Don’t be fooled by how easy it sounds. Short selling is a sophisticated trading technique that only experienced investors familiar with stock market nuances should try.

The assumption in short selling stocks is that the stock price will decline, the investor will buy it back at a lower price and sell it to the lender. The difference between the buy and sell price is the trader’s profit.

Shorting a stock carries a significantly higher risk compared to the risks of passive or active trading. When an investor buys a stock, they risk only the principal stake in the trade. So if they bought a share for $100, they risk just $100.

However, the investor can lose a lot of money due to short selling risk. For instance, from the $100 share example, if the price doesn’t fall and rises to $250, the investor would lose $150.

What is Short Selling Stock?

In the short selling process, the short seller trades in borrowed stocks. The trading is done through brokers that offer this service. The broker buys the stock, they lend it to you, and you sell it. Once the stock is sold, your account with the broker is credited with the sale proceeds. You agree to buy the stock sometime in the future to return the loan to your broker. This process is known as covering the short.

Now let’s talk about why short selling is good. The broker earns a fee from the investors shorting stocks. The broker will also get any dividends issued during this time. As an investor, you buy stocks you forecast as declining in price based on market stability. If the price doesn’t fall, you are out by the transaction charges. If prices rise, you lose the price increase amount and the transaction fees.

The risks of short selling lie with the investor. The broker’s fee is guaranteed, and the broker can also force to sell the stock, known as covering the short at any time. This means that you buy the stock on the day the broker asks you. If prices on that day are higher than your short rate, you have to bear the difference, which is your trading loss.

However, most brokers ask for investors to cover the short if other traders want to short sell the stock. It is usual for prices to rise, and you can cut your losses in such a case. This happens because many traders shorting a stock push its price upwards.

Pros of Short Selling

Some of the primary advantages of short selling are as follows:

Little Capital Injection Needed

One of the advantages of short selling is that it allows investors to earn a significant profit without paying out the capital amount needed. Only the fee is required upfront, and the rest will be required by the deal’s close. This means that if the prices fall, you stand to earn a profit on an outlay of the broker’s fee.

Earn Money in Falling Markets

Shorting the market is the only way that investors and fund managers can make money in falling markets. If the market situation affects the stock price in such a way that stocks are falling, the only way to earn a profit is by utilizing shorts in the market.

Hedging a Portfolio

Having shorts in your portfolio allows them to hedge your portfolio if you have the stock in your portfolio. If you hedge against the stock falling, you don’t lose if the price drops and your investment is at risk. This can help in managing volatility risk for significant funds.

Cons of Short Selling

Some of the primary disadvantages of short selling are as follows:

Limited effectiveness

As investors investing on the assumption of falling markets is an impractical approach. Markets have both price rises and falls. This means that focusing on just the price falling limits the range of profit potential. The loss potential is also high.

High Risk

Due to the limited range of profits, the risks are very high. If the share price rises, the investor must bear the increased price differential and the broker’s fees. The short sale stock process can push a regular market adjustment and make it into a significant dip. The 2008 crisis provided many examples where using short selling pushed stocks into bankruptcy.

Some short selling stock examples that resulted in crashes are stocks like Bear Stearns in early 2008 and Fannie Mae, Freddie Mac in mid-2008. Short positions in Lehman Brothers in the fall of 2008 eventually initiated the financial crisis of 2008.

Advantages and Disadvantages of Short Selling

The pros and cons of short selling are summarized below:

short selling pros and cons table - photo

The risks in short selling seem to outweigh the short selling benefits. The only attractive feature in shorting is the hedging it offers to large portfolios from downside risk.

Short Selling Example with Explanation

Let’s see what happens when you short a stock in real life. Assume that the shares of AAPL are trading at $100, and you expect them to fall. You borrow 300 shares from a broker and sell them for the same price. You sell them for $100 and earn $30,000.

The shares fall to $70 in the market.

You now buy 300 shares for $70, which costs you $70 x 300 = $21,000, and you settle your debt with your broker.

Your net profit from the whole exercise is $30,000 - $21,000 = $7,000.

But what does short selling stock mean for investors if the stock price doesn’t fall? Let’s take a look at the opposite scenario:

Assuming that the shares of AAPL are trading at $100 and you expect them to fall. You borrow 100 shares from your broker and sell them at the same price. You sell them for $100 and earn $10,000.

The shares rise to $110 in the market.

You must now buy 100 shares for $110, which costs you $110 x 100 = $11,000 and settle your debt with your broker.

Your loss will be $10,000 - $11,000 = -$1,000.

Commission fees for the brokers would apply on both stages of the transactions, so many zero commission brokers do not offer short selling transactions.

Final Thoughts

Shorting stocks is a standard trading option for investors that have a lot of experience. It is also popular amongst hedge fund managers as it allows them to protect their portfolios from downside risks.

While keeping shares available to short can help create enormous profits, the investor also risks losing a lot of money.

If the market meets expectations, short sellers meaning to secure profits keep the amount leftover from the price they sell and the price they buy at. However, if the price of the shares rises, the trader will make a loss since they would have sold for lower and will buy at a higher price.


What does sell short mean in stocks?

Selling short implies that the seller is selling stock that they don’t own at the time of sale. Experienced traders also know that trading short means that the seller expects the stock price to fall.

What is a short seller?

A short seller sells short stocks or looks to make a profit from selling short stocks.

Does short selling involve borrowing stock?

Short selling stocks involve borrowing as the short seller “borrows” the shares from the broker and sells them in the market. The cycle is completed when the seller pays off the loaned shares by repurchasing them from the market.

Download Gainy to find stocks that match your portfolio and goals

Sign up
Sign up
Rate this article, if you like it
votes  /  average rating:
Not helpful
Nice but boring
Interesting and useful
Marry me Author
Download Gainy to find stocks that match your portfolio and goals
Try Gainy
This is some text inside of a div block.
Headings, paragraphs, blockquotes, figures, images, and figure captions can all be styled after a class is added to the rich text element using the "When inside of" nested selector system. Headings, paragraphs, blockquotes, figures, images, and figure captions can all be styled after a class is added to the rich text element using the "When inside of" nested selector system.
This is some text inside of a div block.
Headings, paragraphs, blockquotes, figures, images, and figure captions can all be styled after a class is added to the rich text element using the "When inside of" nested selector system. Headings, paragraphs, blockquotes, figures, images, and figure captions can all be styled after a class is added to the rich text element using the "When inside of" nested selector system.
Arrow icon
Arrow icon
because I want to check what my friend has just sent me
The company developed and maintains technological products and services, namely Snapchat, Spectacles, and Bitmoji. Snapchat is the third most popular app among millennials and gets high profits from ads on the platform. Since TikTok is not available to invest in yet, Facebook is boring, we see Snap as a good choice to diversify your portfolio. We don’t know what keeps those kids so glued to screens in Snapchat but if companies profit from it, we can get a share thanks to investing in their stocks.
because xBox brings us together with friends
Microsoft is the second biggest company on the market in terms of capitalization. Xbox, Skype, Windows Office 365 are all part of Microsoft business as well as it develops, licenses, and supports a wide range of software products and services, as well as designs and sells hardware. The company’s future is as bright as it’s past with all the money the company invests in disruptive tools like AI. Next time you plan to buy another game for the Xbox console, you might also consider buying a Microsoft stock which is not very expensive.
because we want schools to be cooler
So we packed peanut butter and jelly sandwiches for the kids, now it’s time to go to school. The K12 Inc. is an educational technology company. The company offers a private education program, software and education services built to teach online for preschool students up to grade 12 or K-12. The company’s earnings soared up after the pandemic because we came to realise that online learning is not far in the future and may continue the trend.
because we like to treat our pets and ourselves, too
The American manufacturer of supermarket food JM Smucker Co also operates a pet food business including brands such as Milk-Bone and Meow Mix. It’s also the producer of the peanut butter JIF, kid’s all-time favorite filling. The company offers a 2.96% dividend yield and in the third quarter reported a 7% increase in net sales.
because we love playing games
If there is one game to teach you financial literacy - it’s Monopoly, which belongs to Hasbro, as well as unparalleled portfolio of approximately 1,500 brands including MAGIC: THE GATHERING, NERF, MY LITTLE PONY, TRANSFORMERS, PLAY-DOH, BABY ALIVE, DUNGEONS & DRAGONS, POWER RANGERS, PEPPA PIG and PJ MASKS, as well as premier partner brands. The company generates strong cash flows and pays regular dividends. The company’s business moves along the online trend and develops digital content in the form of TV shows, films, computer games.
because everyone has a favorite childhood hero
Disney is a widely diversified company which owns everything from toys to apparel, and books to video games: Disney Parks, ESPN channel, Pixar, Hulu and so much more. And now it bets on streaming services with Disney+ and threatens Netflix’s market share. The company revenue suffered a major drop last year due to closure of Disneylands, but has opened them in October and foresees a strong comeback.
Thank you!
Your submission has been received!
Oops! Something went wrong while submitting the form.
By clicking "Submit" you accept our Privacy Policy.
Get Started
What is Gainy, what settings do you have?

Gainy is not an app to invest in stocks, but a screener and stock portfolio analysis app. We help our clients to identify the right stocks, depending on portfolio, personal goals, and fundamental analysis.

We work as a stock analyzer and stock comparison app: give the possibility to create collections tailored to personal needs, show charts and shares and allow users to track finance flows and dividends distribution.

You can use Gainy as a guide and stock picker: set your goals, get tips & forecasts, and pick up the right investments to gain your wealth.

Is Gainy complicated to use?

One of the benefits of Gainy as a stock market investment app is convenience. We will become your Spotify in the world of investments with simple and intuitive functionality. Tracking, forecasting, analyze and compare of portfolios — everything we do as a stock screener app is complicated, but what you do is really not. We took care of it.

Can I buy a stock using Gainy?

At the current moment, Gainy is not a stock investing app, and you can’t directly buy stocks using it, but in the future, we definitely will provide this feature. We work on Gainy updates to make it a stock market app and will inform you when these trading features are ready.

Is your stock investment app free?

We have Basic and PRO access. As a trader or retailer, you can use both and decide which one is more comfortable for you.

What goal can I set?

Gainy is a fundamental stock screener app that can help you to set & gain your financial goals and track your money deposits. It can be anything from “I want my money to work” to gain an amount of money for a new house. As stocks portfolio app will help you to make the investment process easy and amusing, not boring. 

Thanks for checking our our articles, we hope you’re finding them useful. If you’re ready for some kick-ass investing ideas, check out our brand new web platform.
Try it now