How can you sell something you do not own? It sounds like magic, but in finance it is common. When you short, you borrow shares from your broker and sell them immediately at the current price. Your goal is to buy them back cheaper in the future, return them to the lender, and keep the difference yourself.
"Fear is only faith in evil instead of good."
— Florence Scovel Shinn
Shorting requires nerves of steel, because you are going against the natural flow of the market, which over time always moves upward.
The risk of shorting
Unlimited loss: When you buy a stock normally, your maximum loss is your investment. When you short, you can theoretically lose infinitely much, because there is no limit to how high a stock can rise!
Advantages
- You can make money even when the entire market crashes.
- Makes it possible to hedge your portfolio against market volatility.
Disadvantages
- Extremely high risk if the stock suddenly shoots up (Short Squeeze).
- You have to pay interest to borrow the shares, making it expensive over time.