Shorting is when one bets against the price of a stock or any financial instrument that allows for such and hope that the price goes down in the near future. When you are shorting a stock you are borrowing the shares and selling it with the obligation to buy it back on a predetermined date and return it. For example, a certain stock is currently at $100 and you think that it’s going to go down in the near future. By short selling it, you are borrowing the shares and selling it at $100 but you will need to buy back the same number of shares at a specified period of time and return it to whoever lent it to you, normally through brokers. If your prediction is right and the stock goes down in value then you will need less money to buy back the same number of shares and you will pocket the difference.
So in our example, if the stock goes down to $70 then your profit is $30 per share which is the difference in price when you borrowed and sold it versus when you have to buy and return it. In this scenario you will have made money but in case you are wrong you could lose a lot of money.
The risk that comes with shorting is very high since the maximum profit you will get is just the price of the stock at the time you borrowed it. In our example of $100 per share, if the share price went down to zero at the time you need to return it then your profit is $100 per share. But if the price went up to $1000 then you will need to buy it at that price so you can return the shares you borrowed. In this example, in order to buy and return the shares, you will need to add $900 to the $100 you originally received for each share. Your loss will be $900 per share versus your potential gain of $100 per share. This is a simplified example to help you understand the associated risk with shorting and I hope it gives you an idea of how risky it is.
Shorting is predicting where the price will go for a specific period of time and therefore it’s the same as timing the market. And as I mentioned in my previous notes, this is not a good strategy towards becoming a millionaire because the odds are significantly against your favor. So just stick to a diversified long term strategy of investing and don’t try to expedite becoming a millionaire.