What is short selling?

Short selling is a trading strategy that involves selling an asset, usually a stock, that the seller does not own. The short seller borrows the asset from a broker and sells it on the open market with the expectation that the price of the asset will decline. The goal is to buy back the asset at a lower price in the future, return it to the lender (broker), and profit from the difference between the sale price and the repurchase price.
Here's a step-by-step breakdown of how short selling works:

1. Borrowing the Asset: The short seller borrows shares of a stock from a brokerage firm, typically through a margin account.
2. Selling the Asset: The borrowed shares are sold on the open market, generating cash for the short seller.
3. Waiting for a Price Decline: The short seller expects the price of the asset to fall. If the price drops as anticipated, they can buy back the same amount of shares at a lower price.
4. Buying Back the Asset (Covering): The short seller uses the cash generated from the initial sale to repurchase the same number of shares at the lower price.
5. Returning the Borrowed Shares: The purchased shares are returned to the brokerage firm, closing the short position.
6. Profit or Loss: The profit or loss is the difference between the sale price and the repurchase price, minus any transaction costs and borrowing fees.

Short selling is a way for traders to profit from a decline in the price of an asset. However, it comes with significant risks. Unlike buying a stock, where the maximum loss is limited to the amount invested, short selling has unlimited risk because there is no upper limit to how much the price of an asset can rise. If the price goes up significantly, the short seller may incur substantial losses.
Short selling is commonly used by hedge funds, institutional investors, and sophisticated traders, but it is important to note that it involves a higher level of risk and may not be suitable for all investors. Regulatory bodies often impose restrictions on short selling to prevent market manipulation and excessive volatility.