What Is Short Selling and How Does It Work? Everything You Need to Know

In this article, we’ll explore what short selling is, how short selling works, and why it’s a valuable strategy for traders in shifting markets. Whether used to hedge against potential losses or to capitalise on anticipated price drops, short selling offers flexibility across various market conditions.

What Is Short Selling?

Short selling is the act of selling an asset you don’t own with the intention of buying it back later at a lower price. This is typically done by borrowing shares from a broker, selling them on the open market, and then repurchasing them after the price falls, returning the borrowed shares and pocketing the difference.

Alternatively, many traders now use CFDs (Contracts for Difference) to short-sell stocks. With CFDs, you’re not borrowing or owning the actual stock. Instead, you’re trading a contract based on the price movement of the underlying asset, making the process simpler, faster, and more accessible.

Example: Imagine a trader believes Tesla stock will fall from $350 to $300. Instead of borrowing shares, they open a short CFD position. If the stock drops to $300, the trader profits from the $50 difference, minus any trading costs.

How Does Short Selling Work?

Let’s break down how short selling works, including both traditional and CFD short-selling approaches:

Traditional Short Selling:

• Borrow Shares: A trader borrows shares of a stock from their broker.
  
• Sell the Shares: The borrowed shares are sold on the open market at the current market price.
  
• Wait for Price Decline: The trader monitors the market, hoping the price drops.
  
• Buy Back at Lower Price: If the price drops, the trader repurchases the shares.
  
• Return Shares to Broker: The trader returns the original borrowed shares and keeps the difference.

CFD Short Selling:

With a CFD (Contract for Difference), you do not own or borrow the underlying asset. Instead, you enter into an agreement with your broker to exchange the difference in the asset’s price between the time you open the position and when you close it.

When you open a short CFD position, you are essentially speculating that the asset’s value will decrease. If the market moves in your favour and the asset price falls, you can close the trade at a lower price. The broker then pays you the difference between your entry price and the exit price, which becomes your profit.

Example: Imagine a stock is priced at $100. You open a short CFD position at this price, expecting it to decline. The stock drops to $90, and you close your trade. You earn a $10 profit per share, depending on the size of your position.

Which Market Can You Short-Sell?

With VT Markets, you can short-sell across a wide range of global financial markets using CFDs. This allows you to speculate on falling prices without owning or borrowing the asset.

Here are the markets where short selling is available:

• Forex: Go short on minor, exotic, and major currency pairs by selling one currency against another.
  
• Indices: Trade major global indices such as the S&P 500, NASDAQ 100, Dow Jones, FTSE 100, and more.
  
• Energies: Speculate on price drops in energy commodities like Natural Gas, WTI Crude, and Brent Crude.
  
• Precious Metals: Short metals such as XAUUSD (gold) and XAGUSD (silver) based on market movements.
  
• Soft Commodities: Trade CFDs on agricultural assets like cocoa, coffee, and cotton.
  
• ETFs: Take short positions on Exchange-Traded Funds across multiple sectors and industries.
  
• CFD Shares: Short-sell popular US, EU, and UK largest companies directly through the platform.
  
• CFD Bonds: Speculate on price declines in global bond markets.

The Difference Between a Long and a Short Position

In trading, the terms “long” and “short” refer to the direction of your market expectation. When you take a long position, you’re buying an asset with the belief that its price will rise, allowing you to sell it later at a higher price for a profit. On the other hand, a short position involves selling an asset you don’t own, or speculating on its price falling, with the intention of buying it back later at a lower price. Essentially, going long means you’re bullish on the market, while going short signals a bearish outlook.

Example: If you think Amazon’s price will increase, you go long, buying the stock at its current price and aiming to sell it higher price. But if you believe it’s overvalued and likely to drop, you go short by short-selling Tesla shares. In both cases, your position depends on the direction you expect the market to move.

Why Do Traders Choose to Short-Sell?

Short selling is more than just betting against the market. Traders use it for different strategic purposes depending on their goals and market outlook.

Profit from Bearish Trends

One of the most common reasons to short-sell is to profit when an asset is expected to decline in value. Traders often look for overvalued stocks, weak earnings, or negative market sentiment as signals to go short. For example, if a major tech company is trading at all-time highs but issues a disappointing revenue forecast, short sellers may act quickly to benefit from the expected pullback.

Hedge Existing Positions

Short selling is also an effective hedging tool. Traders who already hold long positions may open short positions to offset potential losses during uncertain market conditions. For instance, if a trader holds a diversified portfolio of U.S. equities but expects a short-term market dip, they might short-sell an index like the S&P 500 to reduce risk exposure without exiting their entire portfolio.

Speculate on Weak Assets

Some traders specialise in identifying underperforming or fundamentally weak assets and shorting them purely for speculative gains. They may use earnings reports, industry news, or technical analysis to spot opportunities. A high-profile example was the wave of institutional short interest in GameStop before its unexpected retail-driven rally. While speculative short selling can be profitable, it also comes with higher volatility and risk.

Conclusion

Short selling is a strategy that allows traders to profit from falling markets by reacting to weak earnings, hedging against volatility, or targeting overvalued assets. Understanding what short selling is and how short selling works is key to using the strategy effectively. While traditional short selling involves borrowing and selling the asset, modern methods like CFDs offer a simpler way to speculate on price drops without owning the asset, making short selling more accessible and flexible for today’s traders.

Short Selling Stocks Today with VT Markets

VT Markets, a regulated and reliable trading platform, gives traders the ability to short-sell a wide range of global stocks through CFDs, all within a single, streamlined platform. Whether you’re trading major names like FAANG companies or spotting short-term opportunities in underperforming sectors, CFD short selling offers the speed and flexibility you need to act with confidence. With seamless integration to MetaTrader 4 and MetaTrader 5, competitive spreads, and fast execution, VT Markets makes it easier to access stocks, indices, forex, and more, all through one account.

Start short selling with VT Markets today and turn market downturns into trading opportunities.

Frequently Asked Questions (FAQs)

1. What is short selling in simple terms?

Short selling is a trading strategy where you borrow and sell a stock now, hoping to buy it back later at a lower price.

2. How does short selling work?

It works by borrowing shares, selling them at the current price, waiting for the price to drop, repurchasing them cheaper, and returning the borrowed shares to make a profit.

3. Is short selling risky?

Yes. Losses in short selling can be unlimited if the stock price rises significantly, which is why stop-loss strategies are critical.

4. What is an example of short selling?

Suppose Tesla shares are trading at $250, and you believe the price will fall. You open a short position by selling the stock (or a CFD) at $250. If the price drops to $230, you buy it back at the lower price, closing the trade with a $20 profit per share. This is a basic example of how a short sell works when the market moves in your favour.