Short Selling

June 2, 2021

Short selling is a strategy that investors use to either speculate the decline of an asset or to hedge their portfolio. A short sale means an investor opens a position on an asset by borrowing shares of that asset. The investor then sells these borrowed shares to buyers willing to pay the current market price. The short selling investor is betting that the price of the asset will decline, and they can purchase the shares back at a lower cost. 

There are multiple advantages and disadvantages when it comes to short selling. One advantage is, there is a possibility of high profits if the asset that the investor shorted declines in value. Another advantage is there is little initial capital needed to borrow the shares. A third advantage is short selling can be used as a hedge against other holdings within an investor’s portfolio. 

A disadvantage of short selling is the losses are potentially unlimited. This can happen is the asset continues to gain value and does not decline back to the initial price the investor borrowed the shares. Another disadvantage is short sellers might have trouble finding enough shares to buy when they are trying to close a position. This happens if a lot of traders are also short the asset or if the asset is thinly traded. 

Advantages 

There is a possibility of high profits if the asset that the investor shorted declines in value Little initial capital required 

There is little initial capital needed to borrow the shares. 

Short selling can be used as a hedge against other holdings within an investor’s portfolio. 

Disadvantages 

There are potentially unlimited losses if the asset continues to gain value and does not decline back to the initial price the investor borrowed the shares. 

Short sellers might have trouble finding enough shares to buy when they are trying to close a position. This happens if a lot of traders are also short the asset or if the asset is thinly traded. 

There is a possibility of a short squeeze. This happens when an asset’s price accelerates higher as short-sellers try and cut their losses by buying back the shares at the current market value. 

 

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