Short Selling of Shares: What’s Behind It?

Short selling of shares is a strategy in finance with which investors can profit from falling prices in the short term. We have summarised everything worth knowing about short selling for you.

Short selling of shares: a definition

Short selling stocks, also known as short selling, is a strategy for making short-term profits. More and more private investors are turning to short selling instead of long-term investment strategies.

• In short selling, the seller or shortseller does not own the shares he is offering on the open market. He sells assets that he has merely borrowed at the time of the sale.
• These covered short sales involve borrowing shares from a bank, broker, fund or other investment institution. Uncovered short selling, i.e. the sale of shares that do not exist, is prohibited in Germany.
• Brokers and co. often require a security deposit: the investor deposits a so-called margin with which he can settle his debts in the event of a losing trade.
• The short sale is made in the hope that the shares in question will lose value within a short period of time. If the expected loss in value occurs, the shares can be bought at a favourable price and returned to the actual owner.
• The seller’s profit is the difference between the sale value and the repurchase value. However, a small lending fee (usually 1.5 to 2% per year) and taxes are usually due.
• It can become problematic if the share price does not fall in the expected time window. As owners, brokers and banks can reclaim their shares at any point in time. If the share value has risen, the seller makes losses.
• The process is also known as “shortening”. Other common expressions are “going short” and “selling short”.

Pros and cons of short selling

Generally, short selling is a risky strategy that requires a thorough knowledge of the market. Often short sellers are considered an aggressive group of investors.

• Short selling has advantages for both sides: They are so interesting for investors and funds because they can also profit from falling prices.
• As an investor, you only tie up your capital for a short time. Once the transactions have been completed, it is available to you again.
• In addition to making a profit, short selling can also be used to hedge stock holdings. The latter is also called “hedging”: Investors and funds sell a portion of their shares short to absorb losses in the event of a sudden price drop.
• The biggest disadvantage is the high risk: if the share value rises against expectations after the short sale, losses can theoretically be unlimited. Even with a stop loss to cap losses, investors can lose large sums.
• Short selling can have a negative impact on the company in question in certain circumstances: a high short selling ratio can reinforce an existing downward trend.