Short Selling

Short selling is a way to profit when a stock’s price falls. Here’s how it works: you borrow shares from your broker and immediately sell them at the current price. Later, you buy the same shares back (hopefully at a lower price) and return them. The difference is your profit.

Say you short a stock at $50. If the price drops to $30, you buy the shares back, return them, and pocket $20 per share. But if the price rises to $70, you still have to buy the shares back to return them, and you’ve lost $20 per share.

Why it matters

Short selling is an advanced strategy and not something most investors need to think about. But it’s worth understanding because it comes up in the news regularly. The GameStop saga in early 2021 was driven by a conflict between short sellers and retail investors. When a heavily shorted stock starts rising, short sellers rush to buy shares to cover their positions, which pushes the price up even further. This is called a short squeeze.

The biggest risk with short selling is that your losses are theoretically unlimited. When you buy a stock normally, the worst that can happen is it goes to zero, meaning you lose what you invested. When you short a stock, the price can keep climbing with no ceiling, and you owe the difference.

Short selling requires a margin account and involves borrowing fees and interest. In Canada, not all brokerages make it easy or available to retail investors. For the vast majority of people, it’s a strategy best left to professionals.

Example

Say a trader shorts 100 shares of a Canadian stock at $40 each, collecting $4,000. If the stock drops to $25 and they buy the shares back, they spend $2,500 and keep $1,500 as profit (minus borrowing fees). But if the stock climbs to $60, buying back those 100 shares costs $6,000, meaning a $2,000 loss on top of whatever fees they owed.