What is Short Selling?

Short selling is when you borrow stock from a broker and then sell it. It’s also pure speculation—with the potential for unlimited losses.

However, you eventually have to buy back the stock on the market, to return it to its owner. If the stock falls in price while you are “short”, you can buy it back at a lower price. You have then made a profit. But if the stock rises in price, then you must buy it back at a higher price than you sold it, and you lose money.

Short selling is pure speculation. It’s what a mathematician calls a “negative sum game”, since the winners have to outguess the losers by a large enough factor to pay associated costs. It doesn’t enjoy any of the advantages of conservative investing. Then too, the returns are upside down. When you buy stocks, gains are theoretically unlimited and the most you can lose is 100%. When you sell short, your maximum gain is 100% (if the stock you’ve shorted goes to zero). But a short seller’s potential losses are limitless.

Profitable short selling requires superhuman timing, and the inevitable mistakes can be super expensive for investors.

As a general rule, we advise against short selling much as we advise against options trading, leverage, currency speculation and bond trading. In all these activities, it’s a rare investor who makes enough profit to compensate for the risk involved.

To maximize your stock market returns, we recommend using our three-part Successful Investor philosophy:

1. Invest mainly in well-established companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

Discover how most investors who successfully build wealth over the long term follow certain investing practices. Find out what they are in our FREE investing guide, The 10 Best Practices of Successful Investors.