How to Short a Stock (And Why It Is Dangerous)
Betting against a company feels smart when the market is crashing. But Short Selling has a fatal mathematical flaw: Your maximum profit is capped at 100%, but your maximum loss is theoretically infinite. Here is the mechanic of “borrowing to sell” and the nightmare scenario known as a Short Squeeze.
1. The Mechanic: Sell High, Buy Low
In a normal trade (Long), you Buy then Sell. In a Short trade, you reverse the timeline: You Sell first, then Buy later.
- Borrow: You locate 10 shares of Tesla from your broker.
- Sell (Open): You sell them immediately to the market for $1,000 cash.
- Wait: You pray the price goes down.
- Cover (Close): You buy 10 shares back at the new price to return them to the broker.
2. The Math: Limited Gain, Unlimited Pain
This table shows why shorting is structurally disadvantaged compared to buying.
| Scenario (Short at $100) | New Price | Result |
|---|---|---|
| Best Case (Bankruptcy) | $0 | +$100 Profit (100%) |
| Good Case (Correction) | $80 | +$20 Profit (20%) |
| Bad Case (Rally) | $150 | -$50 Loss (-50%) |
| Nightmare (Squeeze) | $500 | -$400 Loss (-400%) |
3. Visualizing the “Infinite Loss”
When you buy a stock, the worst thing is it goes to zero. When you short, there is no “ceiling.”
| Position Type | Investment | Max Potential Loss |
|---|---|---|
| Long (Buy) | $1,000 | |
| Short (Sell) | $1,000 |
4. Strategy: What to Short?
Professional short sellers do not short “expensive” stocks. They short “broken” ones.
- Don’t Short “Overvaluation”: Tesla and Amazon looked “expensive” for a decade while rising 1,000%. Being early is the same as being wrong.
- Do Short “Fraud/Bankruptcy”: Look for accounting scandals, lying CEOs, or broken business models (like Blockbuster vs Netflix).
- Wait for a Catalyst: Never short a rising stock. Wait for the chart to break (downtrend confirmed) or bad news to hit.
5. Warning: You PAY the Dividend
It gets worse. Shorting has carrying costs.
⛔ The Hidden Costs
- Dividend Payments: If you are short a stock on its ex-dividend date, YOU owe the dividend to the lender. It comes out of your cash.
- Borrow Fees: Hard-to-borrow stocks (like meme stocks) can charge 50%+ annual interest just to hold the position.