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How does short-selling work?

Curious about short-selling

How does short-selling work?

Shortselling is a trading strategy that allows investors to profit from the decline in the price of a security (such as stocks, bonds, or commodities). Here's how shortselling works:

1. Borrowing Securities: To initiate a short sale, the investor needs to borrow the securities they want to sell short. They do this by borrowing the securities from a broker or another investor who already owns them. The borrowed securities are then sold in the market.

2. Selling the Securities: Once the investor has borrowed the securities, they sell them in the market at the current market price. This creates a short position, as the investor now owes the broker or lender the same number of shares they borrowed.

3. Waiting for Price Decline: The shortseller believes that the price of the borrowed securities will decrease in the future. They aim to buy back the securities at a lower price to return them to the lender.

4. Closing the Position: If the price of the borrowed securities indeed declines as expected, the shortseller buys back the same number of shares in the market to cover their short position. This is known as "covering the short."

5. Profit or Loss: The shortseller's profit is the difference between the selling price and the lower repurchase price, minus any borrowing fees and transaction costs. However, if the security's price rises instead of falling, the shortseller will incur a loss, as they must buy back the securities at a higher price than they sold them.

It's important to note that shortselling carries higher risks compared to traditional long positions, where investors buy a security in the hope that its price will rise. When shortselling, the potential loss is theoretically unlimited since there is no limit to how much the price of a security can rise.

Shortselling is often used by investors to hedge against potential losses in their long positions or to take advantage of perceived overvalued securities. However, it requires a good understanding of the market, careful risk management, and may be subject to regulations and restrictions to prevent market manipulation. Additionally, not all securities are available for shortselling, and the availability may vary depending on the brokerage and the specific security.

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