Shorting a stock means opening a position by borrowing shares that you don't own and then selling them to another investor. Shorting, or selling short, is a bearish stock position -- in other words, you might short a stock if you feel strongly that its share price was going to decline.

　　Short-selling allows investors to profit from stocks or other securities when they go down in value. In order to sell short, an investor has to borrow the stock or security through their brokerage company from someone who owns it. The investor then sells the stock, retaining the cash proceeds. The short-seller hopes that the price will fall over time, providing an opportunity to buy back the stock at a lower price than the original sale price. Any money left over after buying back the stock is profit to the short-seller.

　　As an example, let's say that you decide that Company XYZ, which trades for $100 per share, is overpriced. So, you decide to short the stock by borrowing 10 shares from your brokerage and selling them for a total of $1,000. If the stock proceeds to go down to $90, you can buy those shares back for $900, return them to your broker, and keep the $100 profit.

　　When short-selling makes sense

　　At first glance, you might think that short-selling would be just as common as owning stock. However, relatively few investors use the short-selling strategy.

　　One reason for that is general market behavior. Most investors own stocks, funds, and other investments that they want to see rise in value. The stock market can fluctuate dramatically over short time periods, but over the long term it has a clear upward bias. For long-term investors, owning stocks has been a much better bet than short-selling the entire stock market. Shorting, if used at all, is best suited as a short-term profit strategy.

　　Sometimes, you'll find an investment that you're convinced will drop in the short term. In those cases, short-selling can be a way to profit from the misfortunes that a company is experiencing. Even though short-selling is more complicated than simply going out and buying a stock, it can allow you to make money when others are seeing their investment portfolios shrink.

　　The risks of short-selling

　　Short-selling can be profitable when you make the right call, but it carries greater risks than what ordinary stock investors experience.

　　Specifically, when you short a stock, you have unlimited downside risk but limited profit potential. This is the exact opposite of when you buy a stock, which comes with limited risk of loss but unlimited profit potential. When you buy a stock, the most you can lose is what you pay for it. If the stock goes to zero, you'll suffer a complete loss, but you'll never lose more than that. By contrast, if the stock soars, there's no limit to the profits you can enjoy. It's quite common for long-term stock investors to earn profits that are several times the size of their initial investment.

　　With short-selling, however, that dynamic is reversed. There's a ceiling on your potential profit, but there's no theoretical limit to the losses you can suffer. For instance, say you sell 100 shares of stock short at a price of $10 per share. Your proceeds from the sale will be $1,000. If the stock goes to zero, you'll get to keep the full $1,000. However, if the stock soars to $100 per share, you'll have to spend $10,000 to buy the 100 shares back. That will give you a net loss of $9,000 -- nine times as much as the initial proceeds from the short sale. And if you think losses like this aren't possible, think again.

　　Still, even though short-selling is risky, it can be a useful way to take calculated positions against a particular company for investors who know what they're doing. Managing your risk is important, but when used in moderation, short-selling can diversify your investment exposure and give you an opportunity to capture better returns than someone who only owns stocks and other investments.

　　Alternative to shorting

　　As a final thought, an alternative to shorting that limits your downside exposure is to buy a put option on a stock. Essentially, a put option gives you the right, but not the obligation, to sell a stock at a predetermined price (known as the strike price) at any time before the option contract expires. For example, if you buy a put option in a stock with a strike price of $100 and the stock drops to $60, you can then buy shares for $60 and exercise your option to sell them for $100, thereby profiting from the decline in the stock.

　　So, the idea behind buying a put option is similar to shorting, although the most you can possibly lose is what you pay for the put option. Now, there's more to trading options than I can explain here, so do your homework if this is a strategy that sounds appealing to you. But it can be a smart alternative to the unlimited loss exposure that comes with shorting a stock.

　　WHAT DOES IT MEAN TO ‘SHORT’ A STOCK?

　　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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　　What is Short Selling?

　　The Basics

　　When an investor goes long on an investment, it means she has bought a stock believing its price will rise in the future. Conversely, when an investor goes short, he is anticipating a decrease in share price.

　　Short selling is the selling of a stock that the seller doesn't own. More specifically, a short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered. That may sound confusing, but it's actually a simple concept. Here's the idea: when you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later you must "close" the short by buying back the same number of shares (called "covering") and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.

　　Most of the time, you can hold a short for as long as you want. However, you can be forced to cover if the lender wants back the stock you borrowed. Brokerages can't sell what they don't have, and so yours will either have to come up with new shares to borrow, or you'll have to cover. This is known as being "called away." It doesn't happen often, but is possible if many investors are selling a particular security short.

　　Since you don't own the stock (you borrowed and then sold it), you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stock splits during the course of your short, you'll owe twice the number of shares at half the price.

　　Why Short? There are two main motivations to short:

　　1. To speculate

　　The most obvious reason to short is to profit from an overpriced stock or market. Probably the most famous example of this was when George Soros "broke the Bank of England" in 1992. He risked $10 billion that the British pound would fall and he was right. The following night, Soros made $1 billion from the trade. His profit eventually reached almost $2 billion.

　　2. To hedge

　　For reasons we'll discuss later, very few sophisticated money managers short as an active investing strategy (unlike Soros). The majority of investors use shorts to hedge. This means they are protecting other long positions with offsetting short positions.

　　Restrictions

　　There are many restrictions on the size, price and types of stocks you are able to short sell. For example, you can't short sell penny stocks and most short sales need to be done in round lots.

　　Short selling also requires that you put up margin. As with a margin buy (long) transaction, the percentage required varies depending on the eligibility of individual securities.

　　Click here to see Desjardins Online Brokerage's short selling margin requirements. Note that the percentages listed include proceeds originally received from the short sale, so that 150% actually represents 100% of the short sale proceeds plus 50% of account margin.