The Short Sale Strategy
When you place a standard buy order, you're requesting to buy a security which you can then retain or sell in the future. When you place a short sale order, you're requesting to sella security which you then buy back at some point in the future. This process involves borrowing shares from your brokerage or a lender that you agree to buy back at a later date.
Short selling is used as a bearish strategy in attempt to profit from the potential price decline of a security. When traders sell a security short, they're anticipating that the market value of the security will drop and they'll be able to buy back the security at a lower price than they sold it for.
Because you don't own the shares involved in a short sale and are borrowing them from a brokerage or lender, you can be charged interest on the shares you borrow based on share availability. You can learn more about this in our “Short Sale Rebate Fee” article.
Short Sale Examples
When you choose to close your short position or buy back the shares, the stock price may have increased or decreased from the time you placed the short sale order. Let's take a look at what this means.
Stock Price Decrease: This may result in a profit when you buy the shares back at the lower price. The profit will be the difference between your proceeds from the initial sale, and the amount you paid to buy the stock back (excluding commissions and fees).
For example, if you sold 100 shares short at a market price of $10 per share, then bought the same number of shares when the price fell to $8 per share, you would have a $200 profit ($1,000 sale price - $800 purchase price = $200).
Stock Price Increase: This may result in a loss. If this happens, you may have to buy the shares back at a higher price, which will result in an overall loss of the difference between the initial sale and the final stock price (excluding commissions and fees).
For example, if you sold 100 shares short at a market price of $10 per share, then bought back those shares when the price rose to $12 per share, you would have a net loss of $200 ($1,000 sale price - $1,200 purchase price = -$200).