What is Short Selling?

Short selling may be used by experienced investors who seek to generate a profit when the price of a stock goes down. Typically, investors buy stocks they think will go up in price, allowing them to sell it at a higher price and keep the difference as profit. This is called going long. Shorting a stock, or short selling a stock, is the opposite. It’s what investors do when they think the price of a stock will go down.

With short selling, it’s about leverage. Investors sell stocks they’ve borrowed from a lender on the expectation the price will drop. The hope is to rebuy and replace the stocks they borrowed at a lower price. The difference between the price they sell the stock at, and the price they buy back the stock at, is the profit.

Keep in mind that you are paying interest to your brokerage, which will reduce the profit you earn on the short sell. However, with short selling comes additional rules, risks and expenses beyond standard self-directed investing.

Before attempting to short sell stocks, you’ll need a margin account.

You must apply and qualify for a margin account in the same way you would for a loan, since you need to prove that you can and will pay back the money you’re borrowing. Since you’re leveraging the brokerage’s money, they want to know that you have the ability to cover your loss, should your trade lose money.

Margin accounts let you borrow money against the securities you already own to buy additional securities. So, when you buy a stock in a margin account, you can choose to only pay a portion of the total stock price and borrow the rest from your brokerage. This is called “buying on margin”.

You can learn more about margin accounts, along with additional requirements and considerations for how they work, here.

While there is no set limit on how long you take to replace the shares you borrowed, your lender can force you to close the position and replace the shares you borrowed. This is usually done when the position is moving in the opposite direction of the short and creating heavy losses, putting the likelihood of the shares being returned in jeopardy.

Though the process may seem simple, it’s important to note that it could be time consuming, particularly likely during the applying and qualifying step.

Remember, most investors aren’t comfortable with short selling as a strategy, since the general expectation is that stock value will increase.

If you’re an investor looking with more of a long-term strategy in mind, buying stocks may be a much less risky path for you to consider.

If you are still interested in short selling, you can get started by applying for a margin account with TD Direct Investing.

Using borrowed money to finance the purchase of securities involves greater risk than a purchase using cash resources only. If you borrow money to purchase securities, your responsibility to repay the loan and pay interest as required by its terms remains the same even if the value of the securities purchased declines. An investment strategy that uses borrowed money could result in far greater losses than an investment strategy that does not use borrowed money.