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What Is Short Selling?

Shorting stocks, or short selling, is a short-term practice that involves speculating on a stock’s future performance for your financial gain.

🤔 Understanding shorting stocks

In the simplest possible terms, shorting a company’s stock involves borrowing shares from a broker, selling them to another investor, and (hopefully) rebuying the shares at a lower price to return to your broker.

If you’re convinced a company is about to take a short-term drop, you may decide to make money on a company’s misfortune for your own gain – even if the company is an otherwise solid investment.

Plus, shorting can provide a way to diversify your investment exposure and boost your returns. Whereas your stock returns are limited by a company’s stock growth, shorting returns give you a chance to profit off their losses, as well.

Some retail investors – though more often portfolio managers and institutional investors – also use short selling as a way to hedge against the downside risk of a long position in the same or related securities. Hedging involves taking an offsetting position to reduce risk exposure and is considered less risky than taking a purely speculative position.

But ultimately, retail investors short sell because the strategy offsets enormous risk with the chance for high-yield rewards. The return on investment (ROI), especially with the use of a margin, provides a potentially inexpensive method to hedge against risks while seeking greater, more immediate profits than long positions.

What this means for you

There are risks to shorting stocks.

Short selling a company’s stock is a great way to make quick cash if you make the right call. However, it’s a risky strategy with limitless downside risk. That is, if the stock’s price increases, there’s no limit to how much money you could potentially owe your broker to cover your borrowed shares.

Additionally, shorting stocks requires a method of investing known as margin trading. When you trade on margin, you open a margin account with your broker, which allows you to borrow money with your investment serving as collateral. Unfortunately, margin trading can be expensive, and there are rules you have to follow.

Short selling also comes with a bit of a bad reputation, and those who engage in short selling may be criticized as callous, ruthless, money-grubbing, or other not-so-nice monikers. But while short selling may seem detrimental, the practice can benefit the market by:

  • Providing liquidity – particularly in the form of more buyers and sellers
  • Preventing bad stocks from becoming overvalued by curbing excessive optimism
  • Offering a legitimate source of data on market sentiment and demand

At the end of the day, it may be best to work with a trusted financial advisor or AI-powered robo-advisor like Q.ai to manage your funds for you—so you don't ever have to lift a finger.

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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