Definition
Short selling is selling a security that the seller does not own, usually borrowed through a broker, with the aim of buying it back later at a lower price and returning it to the lender. The seller gains if the price falls and loses if it rises.
How it works
The seller borrows shares, sells them, and later buys shares to return. While the position is open the seller pays borrowing costs, owes any dividends paid on the shares, and must keep margin in the account. Rules vary by market, and regulators may restrict short sales to permitted securities or ban them in stressed markets.
Risk is asymmetric. The price cannot fall below zero, so the maximum gain is the sale proceeds less costs, but it can rise without limit, so the potential loss is unbounded. A short squeeze, where rising prices force shorts to buy back, or a recall of the borrowed shares can worsen losses.
Formula / convention
Short profit or loss = (Sale price − Buyback price) × Shares − Borrowing costs − Dividends owed − Trading costs
Illustrative example
A fictional trader short sells 1,000 shares of Sample Co at HK$20, receiving HK$20,000 of sale proceeds. If the price falls to HK$15 and the trader buys back, the profit is (20 − 15) × 1,000 = HK$5,000 before costs; if it rises to HK$60, the loss is (60 − 20) × 1,000 = HK$40,000. The most that can be gained is HK$20,000, but there is no ceiling on the loss.
What to watch for
A short position's potential loss is unbounded because there is no ceiling on a price, and borrowing costs, share recalls and short squeezes can force a position to be closed at the worst time.