Investing in the stock market is already a gamble, but some investors are bigger risk-takers than others. Short selling a stock is a big risk to take with a potentially damaging impact.
What is a short stock?
A short stock, or short selling a stock, is when you borrow shares of a stock from an owner and immediately sell them. You’re hoping the stock tanks and you can buy back the stock at a cheaper price, pay back the lender for the shares you borrowed, and keep the extra cash.
Most investors who short stock are certain that the stock will tank and they’ll be able to earn some fast, easy cash. But it’s not guaranteed.
Short stocks are fine among market experts and those who have been following trends either as a profession or in practice for years. It’s difficult to successfully short a stock if you aren’t a stock market professional.
When shorting a stock might be a good idea
If you’re looking to get fast money and you know that a stock is going to fall soon, short stocks might work. But it’s only a good idea if it actually works.
Say a company’s stock is currently $50 a share. You borrow 20 shares from a broker and immediately sell them, getting around $1,000 from the sale.
When the company’s stock plummets to, say, $10 a share, you can scoop up the 20 you sold for $200. You return the stocks you borrowed, making $40 a share, or $800.
This only works if the stock actually declines. Otherwise, you’re going to have to close your short — or return the stocks — and lose money.
Shorting stocks isn’t for a novice investor. It’s best for a professional or someone who knows the market exceptionally well.
Why short stocks aren’t a great idea
If you’re new to investing, it’s best learn how to keep your money on the positive track. Shorting a stock isn’t something you should do unless you’re an expert in the stock market and investing in stocks.
Say your short was $1,000 from the sale and instead of a stock tanking to $10 a share, it rises to $80 a share. You still owe those shares to the borrow, so you buy them back for $1,600 and lose money.
Keep in mind that you don’t necessarily have to pay back your short stocks immediately. You could wait years before doing so, especially if you’re not willing to buy back a stock when the share price has gone up.
How to determine if shorting a stock is right for you
Are you thinking about doing a short stock? Here’s some things to keep in mind before you make your decision.
- Your (in)experience matters. If you’ve never done this before, talk to a market professional, financial advisor, or investment expert. This isn’t something you should do on a whim.
- Talking heads are just a voice. If you follow celebrity investors who tell you they plan to short a stock, that doesn’t mean you need to jump off a bridge as well. Try not to take the advice of only one person. Find out from other investors what they think of the move.
- Not everyone’s portfolio is your portfolio. See how much money you could risk losing by shorting a stock. Will it set you back hundreds of dollars? Thousands? Tens of thousands? What amount can you lose? If you can accept that figure, then you’re fine.
In general, investing in stocks is risky, but shorting a stock is a major risk and you need to accept that you might not earn any money. Don’t go into short stocking unless it’s something you’ve studied for a long time or your investments can withstand a major loss.