What is short selling? Understand how investors make money betting against the stock market

Short selling is a technique used by investors to profit from a decline in the price of stocks.

In short selling, an investor borrows stock from his or her brokerage firm and sells it on the open market. The trader then waits for the stock price to drop before buying back shares at a lower price and returning them to their broker. If the price does fall as hoped, the investor keeps the difference as profit — minus any transaction fees and interest charges on the borrowed shares.

An example of short selling

If an investor borrows 100 shares of KYZ at $100 per share and sells them for $100 each on the open market, then at expiration (or settlement) the seller has to buy back those 100 shares for the current price and give them back to the lender. If KYZ share price falls to $80 at expiration, then the investor has to buy back those 100 shares at $80 each and return them to the broker/lender, who gives the investor a $20 per share profit, minus any transaction fees such as commissions, etc. However, if the price of ABC shares increases to $110, the investor will make a loss of $10.

Why do traders short stocks?

To make money from volatile stocks

When there’s volatility in the market as a whole or within specific sectors, for example, oil and gas companies, it can create opportunities for investors who want to take advantage of these ups and downs in share value.

Day traders also use this strategy with volatile penny stocks that can rise and drop in price within hours.

To hedge against other investments

If you own stocks or other securities that have an inverse relationship with another security, you may want to protect your portfolio by shorting them so that if one asset goes up, the other goes down by an equal amount. This hedges against risk if one asset rises too much compared with others in your portfolio.

Speculation

An investor may speculate that a certain stock will drop in price, due to different factors such as; financial analysis, news, products sold by the company, public image, future plans and a company’s track record.

Tesla, the famous electric Automaker didn’t always have the fanfare and trust among investors. There were a lot of investors who decided to short-sell Tesla’s stock. Unfortunately for them, Tesla stock skyrocketed. According to Business Insider, Tesla short-sellers lost $38 billion throughout 2020.

Pros of short selling

Short selling diversifies and hedges your portfolio.
You can make money when the price of a stock declines.

Cons of short selling

The cost adds up. Some stocks have a harder-to-borrow price plus other costs such as dividends.
It’s risky. Timing a decline of a stock can be a challenge.
Losses are potentially unlimited while gains are limited by the size of your position. (A stock can rise unlimited, but it can only drop to 0)
Markets generally go up over time.

Can you short sell with Wealthsimple Trade?

Wealthsimple trade is Canada’s answer to America’s popular Robinhood platform. With zero commissions and no minimum funds, it’s one of the most popular trading platforms in Canada. However, there is no option to short-sell stocks with Wealthsimple Trade; maybe in the future. Sign up for Wealthsimple with our link and receive up to $3000 cash, to trade stocks or crypto. You can also read our review of Wealthsimple Trade here.

Can you short-sell with Questrade?

Yes, Questrade allows short selling. However, it won’t work with TFSA or RRSP accounts. You need to have a margin account.

Open a Questrade account today and receive a $50 trade commission rebate when you open and fund any self-directed account. Or if you prefer a managed account, the first $10,000, will be managed for free for a year. Click the link below to check out Questrade.