Template:Short selling - layman

“Short selling”, “shorting” or taking a “short position” in a share is to bet that its price will fall. Shorting is therefore the opposite of buying and holding a share (known in the trade as going “long”).

What’s the difference between ordinary selling and short selling? In normal life you buy things you want but don’t already have, and you sell things you already have but do not want. Short selling is to sell something you don't already have.

This is where the concepts of “long” and “short” and flat are useful. They talk about your economic “exposure”.

If you do not own a share at all, you are “flat”: indifferent to whether its price changes. You have “no exposure”.

If you buy the share, you go “long”: it it goes up, you gain. If it goes down, you lose. This is “positive exposure”

If you sell it again, you become flat again. Back to no exposure.

How would you get negative exposure? In order to go “short” you would have to somehow sell a share you don’t already own — and therefore go from flat to negative exposure. Logistical problem, though: how do you get hold of a share you don't already own?

You borrow it. But what you borrow you must, at some point, return. When that time comes, you must buy the share back in the market, so you can give it back to the lender. This is how you get that negative exposure: the cheaper the share is to buy back, the more gain you make.

The process of “putting on a short” is therefore two separate transactions: a “stock loan” with a stock lender, for which you pay the lender a running fee, and a share sale to a different buyer in the market. To “close out your short”, you must do the reverse: buy a share in the market, and redeliver it to your lender to terminate the stock loan.

Short selling is risky. Your potential profit is limited, because shares cannot go below zero value. Your potential loss is unlimited: shares can go up in value without theoretical limit. This is the opposite (of course) to long investing, where your upside is unlimited, but you can only lose your current investment.