What Does it Mean to ‘Short’ a Stock?

HerMoney Staff  |  August 6, 2019

It can be a quick way to make some money, or lose quite a bit if you aren't careful. But what does it really mean to short a stock?

When watching a sports game, would you bet on who’s going to lose? This is the basic concept of shorting a stock.

Essentially what “short-sellers” do is bet that a stock, sector or broader benchmark will fall in price.

What Does it Mean to ‘Short’ a Stock?

Shorting a stock is for an investor to hope the stock price goes down. The investor never physically owns the stock during the shorting process. (“Long investors” bet that prices will rise.)

Here’s a simplified example of how shorting works:

Say you think Company ABC is overpriced at $50 a share. You borrow 100 shares from your broker — paying interest on the loan — and sell them for $5,000. Time ticks on, and as you suspected, the stock price falls. At $40 a share, you buy 100 shares for $4,000 and return them to your broker. You walk away $1,000 richer, minus investing costs.

That’s a successful short. But what if the stock gains in popularity? Say the price rises to $60 a share, or $6,000 for those 100 shares you need to return. You’re out $1,000.

Shorting, in short, is a strange transaction. You’re selling something you don’t own. And the goal is to sell high and then buy low, says Ryan Bend, senior portfolio manager of the Federated Prudent Bear Fund (BEARX), as opposed to the common game plan of first buying low then selling high.

So What Happened with GameStop? 

This is where things get interesting. Multiple large hedge funds, including one called Melvin Capital, were shorting the stock of GameStop, expecting its price to drop. But a Reddit message board called Wall Street Bets heard about it, and instead gathered en masse to buy the stock in an app called Robinhood, causing its price to soar. This left the hedge funds in what you call a squeeze, where they had to buy the stocks to pay them back, no matter how high the price was, and Wall Street reeling at the ability for this to happen. (Note: This happens all the time, but not usually at this scale.) You can read more about the GameStop issue here, or listen to our podcast for more info.

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