In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to the lender. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as he will pay less to buy the assets than he received on selling them. Conversely, the short seller will incur a loss if the price of the assets rises. Other costs of shorting may include a fee for borrowing the assets and payment of any dividends paid on the borrowed assets. Shorting and going short also refer to entering into any derivative or other contract under which the investor profits from a fall in the value of an asset.

Going short can be contrasted with the more conventional practice of "going long", whereby an investor profits from any increase in the price of the asset.

Concept

To profit from a decrease in the price of a security, a short seller can borrow the security and sell it, expecting that it will be cheaper to repurchase in the future. When the seller decides that the time is right (or when the lender recalls the securities), the seller buys equivalent securities and returns them to the lender. The process relies on the fact that the securities (or the other assets being sold short) are fungible; the term "borrowing" is used in the sense of borrowing £10, where a different £10 note can be returned to the lender, rather than in the sense of borrowing a car, where the same car needs to be returned.

A short seller typically borrows through a broker, who is usually holding the securities for another investor who owns the securities; the broker itself seldom purchases the securities to lend to the short seller. The lender does not lose the right to sell the securities while they have been lent, as the broker will usually hold a large pool of such securities for a number of investors which, as such securities are fungible, can instead be transferred to any buyer. In most market conditions there is a ready supply of securities to be borrowed, held by pension funds, mutual funds and other investors.

The act of buying back the securities that were sold short is called "covering the short" or "covering the position". A short position can be covered at any time before the securities are due to be returned. Once the position is covered, the short seller will not be affected by any subsequent rises or falls in the price of the securities, as he already holds the securities required to repay the lender.

The terms shorting and going short are also used as blanket terms for tactics that allow an investor to gain from the decline in price of a security. Such tactics are generally based on a derivative contract, such as an option, a future or a similar synthetic position. For example, a put option consists of the right to sell an asset at a given strike price; the owner of the option therefore benefits when the market price of the asset falls below that price, as he can buy the asset at the lower price and sell it under the option at the strike price. Similarly, a short position in a futures contract means the holder of the position has an obligation to sell the underlying asset later at a given price; if the price falls below the given price, the person with the short position can buy the asset at the lower price and sell it under the future at the higher price.

Worked Example

If shares in XYZ Company currently trade at £10 per share, a short seller can borrow 100 shares of XYZ Company and immediately sell those shares for a total of £1,000. If the price of the shares falls to £8 per share, the short seller can buy 100 shares back for £800, return the shares to lender and keep the £200 profit (minus borrowing fees). However, if the price of the shares in XYZ Company instead rises to £25 per share following the short sale, and the short seller is required to return the shares, the short seller would have to buy back 100 shares at £2,500 and would make a loss of £1,500 (plus borrowing fees).

Comparison with long positions

Short selling is the opposite of "going long". A short seller takes a negative, or "bearish" stance, believing that the price of a security will fall. Investors who employ short selling often use it to allow them to profit on trading in securities which they believe are overvalued, just as traditional long investors attempt to profit on securities which are undervalued by buying them.

Because a short position is the opposite of a long position, many features of the position are reversed in comparison. In particular, the profit (rather than the loss) is limited to the value of the security, but the loss (rather than the profit) is unlimited. In practice, as the price of a security rises the short seller will receive a margin call from the broker, demanding that the short seller either cover his short position (by purchasing the security) or provide additional cash in order to meet the margin requirement for the security, which effectively places a limit on the amount that can be lost.

Short selling introduction Topic - Technical Analysis

Technical analysis is a security analysis discipline for forecasting the future direction of prices through the study of past market data, primarily price and volume.