Short Selling Stocks

Short selling (also known as “shorting,” “selling short” or “going short”) refers to the sale of a security or financial instrument that the seller has borrowed to make the short sale. The short seller believes that the borrowed security’s price will decline, enabling it to be bought back at a lower price for a profit. The difference between the price at which the security was sold short and the price at which it was purchased represents the short seller’s profit (or loss, as the case may be).

KEY TAKEAWAYS

• Short selling entails taking a bearish position in the market, hoping to profit from a security whose price loses value.
• To sell short, the security must first be borrowed on margin and then sold in the market, to be bought back at a later date.
• While some critics have argues that selling short is unethical because it is a bet against growth, most economists now recognize it as an important piece of a liquid and efficient market.

Is Short Selling Ethical?

Short selling is perhaps one of the most misunderstood topics in the realm of investing. In fact, short sellers are often reviled as callous individuals who are only out for financial gain at any cost, without regard for the companies and livelihoods destroyed in the short-selling process. Worse, short sellers have been labeled by some critics as being unethical because they are betting against the economy.

The reality, however, is quite different. Far from being cynics who try to impede people from achieving financial success—or in the U.S., attaining the “American Dream”—short sellers enable the markets to function smoothly by providing liquidity and also serve as a restraining influence on investors’ over-exuberance.

Excessive optimism often drives stocks up to lofty levels, especially at market peaks (case in point—dotcoms and technology stocks in the late 1990s, and on a lesser scale, commodity and energy stocks from 2003 to 2007). Short selling acts as a reality check that prevents stocks from being bid up to ridiculous heights during such times.