CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.Between 51%-81% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Short selling is a trading strategy that lets you sell a stock before buying it, with a focus on making money from the stock declining in value in between the 2 actions. It tends to have a shorter time frame than buying stocks. Shorting can be used for speculation and to hedge investment risk for a long position in the same stock.
Quick note
This isn’t for a first-time investor. It’s more complex and risky than traditional investing, so it’s really only suitable for those who have a bit of experience in the field and know their way around this type of trading. Head to our investing page if you’re not quite as experienced.
Shorting has an infinite loss potential – the stock you’ve shorted going down in value will make a profit until that stock reaches zero, but if your prediction was wrong, and that stock price rises, it could rise infinitely, which means that your losses can be infinite. Take a look at the risks of shorting to understand this further.
How does shorting work?
When you short sell, you choose a stock that you think will go down in value by a set date. For example, say you thought that Amazon’s stock price is likely to go down in value – you might choose to short sell the stock.
But, to sell something, you’ve got to already own it, right? Not in this case. You can borrow the stock from your provider to sell it, then when you purchase it back later, you can give it back. You don’t have to hunt for someone to let you borrow their stocks – opening a sell position with a CFD provider will automatically do this for you.
The actual act of short selling is pretty simple. You just need to open up the app or website of your chosen provider, find the stock you want to sell and hit sell. But there’s more to it than that if you don’t want to just lose all of your money.
Short selling for a loss is when you lose money from shorting a stock. Short selling for a profit is when you make a profit from short selling – which is what investors are aiming for.
How is short selling different to investing?
Investing in the traditional sense is long term. Investors buy stocks that they think will see long-term growth — typically because they have faith in the company or because their values are aligned with the company values. Often, people will hold investments for years.
Shorting is more speculative. You might make a decision to short a company because it’s getting negative press or because it’s reported less than expected earnings. It’s less to do with your values – in fact, you’re more likely to short a company that you don’t believe in.
Short selling
Investing
Time frame
Short term – you don’t tend to hold positions for very long
Long term – positions are held for weeks, months or even years
Effort required
A fair amount – you should check quite often as a lot can happen very quickly. Stop loss and take profit orders can help you out here.
Not much – you wouldn’t usually check in often. It’s often recommended that you leave your investments alone, even during volatility.
Choose a stock that you think will go down in value.
Choose a trading provider that lets you short sell – this will be a provider that lets you trade contracts for difference (CFDs).
Borrow as much of the stock as you want to sell from your trading provider (often this happens in line with the next step).
Find the stock on your trading provider’s website. You might need the stock code for this. A simple web search of the company name followed by “stocks” can get you this information.
Open a short position, choosing how much you want to sell.
Adjust any stop loss or take profit settings.
Close your position or buy the shares back. If all has gone well, you’ll have bought them back for less than the value that you sold them for, meaning you’ll have made a profit.
What is stop loss and take profit?
Stop loss Stop loss is a tool that can help you protect your investment to some degree. By choosing to use stop loss, you’re effectively instructing the provider to close at a specific rate. You can choose the value that you want it to close on in pounds and pence (or whatever currency it is traded in), or you can choose based on the amount you would lose.
Take profit Take profit is the same as stop loss, just the other way around. Here, you enter the value that you want your position to close when it works in your favour. Again, you can choose based on the value of the stock or based on the amount of profit you’ll potentially make.
How to use these features You might be tempted to make the stop loss just a little bit higher than the stock’s current value and make the take profit miles below the current value (and the opposite when buying). There’s a key reason why this won’t work.
It’s a race. You’re hoping that the stock’s value will get to take profit before it gets to stop loss, but stocks move up and down over a matter of seconds. If you load up a live stock chart and watch it for even a minute, the value will change constantly. The chances of it reaching your stop loss before it reaches your take profit are pretty high.
Example: Short selling
Charmaine wants to short Disney stocks. She watched the latest Toy Story film and thought it wasn’t as good as the rest. She’s also researched its financials and thinks the stock price will go down*.
*This is purely hypothetical. The latest Toy Story film was great.
At the time of writing, the stock price for Disney is US$124.97. For the sake of the example, let’s just round it to US$125.
So Charmaine thinks that in the next week, the price of Disney’s stock will decline in value. She opens a sell position for 50 shares. She’s now “short” 50 shares of Disney.
Charmaine could set a stop loss for, say, US$130 and a take profit of US$120. That means if the stock moves more than $5 in either direction, the position is closed for her. She’s using a provider with a mobile app that will give her a notification to let her know. In this example, at US$120, she’ll make a profit, and at US$130, she’ll make a loss.
The next part is the waiting game. Usually, with investing, you should steer clear of looking at your investments all the time, but with this, you’ll want to keep a bit of an eye on it. Don’t sit at your desk at work constantly refreshing the page, though. It’ll waste your time and frustrate you.
That’s all there is to it – if the stock price does go down, she’ll be able to see approximately how much she’ll have made. A negative movement doesn’t necessarily mean she’s made money. There are some costs involved. If the negative movement is more than the costs for the trade, Charmaine’s got herself a profit.
Charmaine will need to manually close the position unless she wants to wait it out to see if it automatically closes at her stop loss or take profit orders.
* This is a fictional, but realistic, example.
What are the costs of short selling?
Margin interest To short sell, you usually need to trade on margin, which means that you’re borrowing in order to trade. You may need to pay interest on the value of the shares that you borrow while you’ve got a position open.
Borrowing stocks Sometimes, it might be difficult to get hold of shares to borrow. There may be a fee that is in place for these stocks.
Dividends Like margin interest, you might be responsible for covering the dividend payments on the stock to the provider that you’ve borrowed the stocks from.
What are the perfect conditions for short selling?
Stocks go down quicker than they go up. This means that you want to get in at the right time to actually make some money from it.
The ideal condition for short selling is a bear market. A bear market is one where the stocks are declining in value – usually by more than 20%. An example of this is the bear market that occurred right at the start of the coronavirus pandemic, where most markets crashed. For short sellers, this was an ideal time to be shorting stocks.
Short selling tips
Don’t start if you’re not completely sure what you’re doing. You can practise with a provider that has a virtual portfolio.
Short in a bear market. This is where stocks are moving down.
Look for stocks that are below their moving average. You can use tools on your chosen trading platform to find out the moving average. Look at 30 weeks or so.
Avoid expensive stocks. You might think that what goes up must come down, but these stocks could grow a lot more.
Do your research. Much like getting a puppy or buying a new car, you should research stocks before diving in.
Shorting is a chance to make the most out of a bear market or a specific stock that’s not doing so well. To reduce costs, try not to leave positions open for too long – timing is everything.
Non-traditional short selling
Borrowing shares from a broker isn’t the only way to short a stock. You can also use the following:
Derivatives. Derivatives allow you to speculate on prices without actually owning the shares. You can short sell through spread betting or CFD trading, but be aware that they’re extremely complex and risky financial instruments. Most investors lose money when trading this way.
Option trading. This is (only slightly) less risky than traditional short selling. You can purchase an option on a stock that allows you to sell it at the initial market price within the option’s expiry date. If the price goes down, you sell, buy back at the new price and make a profit. If the price goes up, you don’t sell at all and only lose the value of the option, thus limiting the risk. With traditional short selling, you can buy back whenever you want (unless the owner of the stock claims it back), whereas options normally have a fairly short expiry date. Read our guide on option trading to learn more.
Risks of short selling a stock
Repeat after us: short selling is for expert investors and you shouldn’t do it unless you know what you’re doing.
The reason why it’s considered very risky is that it could make you lose “infinite” money. When you buy a share and “go long”, the maximum you can lose is the amount you invested. When you “go short” instead, there are no theoretical limits to how much share prices could go up, and thus to how much you could lose. Not good.
It’s especially dangerous if a lot of people are short selling shares from the same company and the price unexpectedly goes up. At that point, everyone will start buying back really quickly, causing the stock to go up even more. It’s what’s called a “short squeeze” and it easily becomes a vicious circle that turns out to be very expensive for short sellers.
Finally, don’t forget that short selling isn’t free. Brokers will charge a fee for lending the stocks, and there are fees for other short-selling methods that you should consider.
Bottom line
Short selling is very different from traditional investing. Instead of choosing stocks that you think will grow and make you a long-term profit, you choose stocks that you think are going to decrease in value over the short term. If you’re a beginner and want to give shorting a go, do it with a virtual portfolio first to see how you get on. Once you think you’ve got the knack of it, try it with small amounts.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
Frequently asked questions
When the price of a stock decreases in value, some people blame short sellers, suggesting that the stock value is driven further down by short sellers. This isn’t the case, however – short selling doesn’t impact the share price of a stock.
The opposite of going short is going long – which means buying a stock.
Not really. Shorting a stock has little impact on the stock price.
Shorting isn’t for the long term – you can short one for as long as you like, but you’ll find yourself paying a lot to keep your position open overnight.
No, but there have been instances where it has been temporarily banned, such as during the 2007 financial crisis.
Zoe was a senior writer at Finder specialising in investment and banking, and during this time, she joined the Women in FinTech Powerlist 2022. She is currently a senior money writer at Be Clever With Your Cash. Zoe has a BA in English literature and a Diploma for Financial Advisers. She has several years of experience in writing about all things personal finance. Zoe has a particular love for spreadsheets, having also worked as a management accountant. In her spare time, you’ll find Zoe skating at her local ice rink.
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