Short selling definition

What is short-selling?

Short-selling is the act of selling an asset that you do not currently own, in the hope that it will decrease in value and you can close the trade for a profit. It is also known as shorting. Short-sellers tend to use this strategy as a method of speculation or as a way of hedging downside risk.

Short-selling strategies can be carried out via a broker, but it is a complicated method, which means that it can be difficult to find a broker willing to lend you the shares to sell. This is why derivative products such as CFDs and spread bets are becoming an increasingly popular method of short-selling.

Example of short-selling

Let’s say that the shares of company ABC are currently trading at CHF 75, but you believe that they are going to decline in value and decide to short-sell the stock. You borrow 100 shares of ABC from your broker and sell them on the open market.

Over the next week the market drops significantly down to CHF 40, so you close your short position and buy back 100 shares of ABC at CHF 40 each.

You calculate the difference between the price of the shares when you borrowed them (75 x 100 = CHF 7500) and the price that you re-bought the shares for (40 x 100 = 4000), which gives you a profit of CHF 3500 – excluding any costs your broker may charge.

However, if you had been incorrect and the market had continued to rise, your potential risk is infinite. Because you have borrowed the stock, your broker may ask for them back at any time and you would have to close out your position at a loss.