What is short-selling and how does it work?

What is short-selling?

Short-selling, also known as ‘shorting’ or 'going short’, is a trading strategy used to take advantage of markets that are falling in price. The traditional way to short-sell involves selling a borrowed asset in the hope that its price will go down, allowing you to buy it back later for a profit. But borrowing the asset comes at a cost, typically a small percentage of the asset’s price.

Short-selling can also be done via CFD trading or spread betting. Both are derivatives that enable you to speculate on price movements without taking ownership of the underlying asset. Most short-selling takes place on shares, but you can short-sell many other financial markets, including forex, commodities and indices.

What makes short-selling different is that you take a position only if you have a negative outlook on the asset’s performance. You likely believe there is limited potential for price growth and that the market is entering a downswing. If you didn’t, you would take a long position instead.

Short-selling is also widely used for hedging, allowing you to offset downside risk in long positions.

How does shorting a stock work?

Short-selling works in two different ways depending on how you choose to trade.

The traditional method involves borrowing the underlying asset from a broker, selling it at the current market price, and later buying it back to return to the lender. If the price falls, you profit. If it rises, you lose, often with exposure to much larger losses than with regular ‘buy low, sell high’ trades.

The second method is using derivatives such as CFDs and spread bets, which do not require borrowing an asset. With CFD trading, you agree to exchange the difference in price from when the position is opened to when it is closed. When you short-sell a CFD, you click ‘sell’ rather than ‘buy’.

For example, if Tesco shares are trading at 450p and you short 100 CFDs, closing the trade at 400p would generate a £50 profit, because you multiply the 50p drop per share across 100 CFDs.

In spread betting, you place a bet on whether the market will move up or down, choosing a value per point. If Tesco shares drop one point and your stake is £1 per point, you make £1.

Be aware that trading on leverage is often perceived as higher risk, you can lose money more quickly than you expect, and past performance is not a guarantee of future returns,.

Which markets can I short-sell?

You can short-sell a wide range of markets depending on your interests, knowledge and risk appetite. These include:

• Shares
• Forex pairs
• Commodities
• Indices
• REITs and property-linked markets

However, shorting shares is most common because they are widely available, highly liquid and easy to track.

Example of short-selling

Suppose Lloyds shares are trading with a sell price of 51.600p. You believe the price will fall, so you short 150 Lloyds share CFDs. A week later, the buy price has fallen to 49.150p, and you close your position. Your profit is £367.50 (51.600 – 49.150 = 2.450 × 150), excluding costs.

If instead the price rose to 54.05p, you would face a loss of the same magnitude.

Short-selling factors to consider

It’s good practice to thoroughly research any shorting opportunity:

1. Perform thorough fundamental analysis
2. Analyse the company’s business model and competitive position
3. Track management changes and accounting quality
4. Size positions appropriately
5. Use alerts and stop losses
6. Consider guaranteed stops to protect against unexpected rallies

Risks of short-selling

Understanding what it means to short a stock includes understanding the risks. Because it involves betting against the market, short-selling carries several risks that long positions do not.

• Unlimited loss potential — a stock’s price can rise indefinitely. If you are short, losses can exceed your initial capital
• Margin calls — short positions use leverage. If the trade moves against you, your broker may require additional funds to maintain the position
• Borrow fees and recalls — with traditional shorting, you pay to borrow shares. If a stock becomes hard to borrow, fees rise, or the lender can demand the shares back, forcing you to close the position
• Dividend and corporate action risk — short sellers owe any dividends paid by the company. Corporate events like splits or takeovers can also move the share price significantly
• Short squeezes — when many traders cover their positions at once, the price can spike dramatically. The 2021 GameStop short squeeze is the most famous example

Short-selling can be effective, but there are times when it’s best avoided. Extremely volatile markets can trigger rapid swings that lead to margin calls or forced closures, while low-liquidity stocks are prone to sudden gaps and sharp squeezes.

It’s also risky to short ahead of major announcements such as earnings, regulatory decisions, central bank meetings or merger news, because these events can move prices unpredictably. Limited borrowing availability can also increase costs and the risk of recall, while highly euphoric and logically inconsistent market sentiment can fuel momentum-driven rallies that lead to steep losses for short sellers.

Why short-sell?

Traders primarily short-sell for two reasons: speculation and hedging.

Short-selling for profit

If you believe a share will fall, short-selling lets you profit from that decline. Heavy short interest can imply market pessimism, but traders are also often blamed for causing downswings. In reality, most research suggests short-selling has little impact on already declining stocks.

Short-selling to hedge

Hedging is the practice of holding two positions to offset potential losses, where a short position can partially protect a long portfolio. While it won’t always eliminate losses, it can reduce your volatility and downside exposure.

Short-interest metrics

Knowing what shorting a stock means includes understanding market sentiment. Short data helps traders assess whether a stock is heavily shorted or at risk of a short squeeze:

• Short interest (SI) — the total number of shares sold short but not yet covered
• Short interest ratio (SIR)/Days to cover — calculated as short interest divided by average daily volume. A high ratio suggests that if shorts begin to close positions, covering could take days, raising squeeze risk
• Short float % — the percentage of a company’s publicly tradable shares currently sold short. A high short float often indicates strong bearish sentiment
• Utilisation rate — shows how much of the stock available to borrow has already been borrowed. Near 100% implies rising borrow fees and squeeze potential

As a stock becomes more heavily ‘shorted’, borrowing costs typically rise and the risk of a short squeeze increases. While potential profits exist if the stock continues to decline, traders face the possibility of rapid, significant losses if a sudden bullish pressure forces shorts to cover.

Controversy and importance of short-selling

Short-sellers are sometimes accused of driving down prices for profit. They have also faced criticism from high-profile executives, including Tesla CEO Elon Musk who once famously called short sellers ‘value destroyers’ during its early battles with bearish hedge funds. Governments have also restricted short-selling during crises, contributing to public suspicion.

However, short-selling improves liquidity, narrows spreads and supports accurate price discovery. Several studies from the 2008 financial crisis show that restricting short-selling increases spreads, reduces trading volume and ultimately harms market efficiency. Short-sellers also scrutinise companies’ financials closely, helping uncover irregularities and improving investor information.

In short, short-selling gives traders a way to profit from falling markets, hedge existing positions and expand their trading opportunities, whether you’re learning what shorting a stock is, how shorting a stock works, or simply clarifying how shorting stocks might fit into your overall strategy.

Short-selling summed up

• You can go short on shares, indices, commodities and forex
• With us, shorting is accessible via CFDs or spread betting
• If prices fall, you may profit; if they rise, you face losses
• Risk management tools are essential
• You can open an IG account and begin shorting in minutes