LONG buy low, hope to sell high, loss capped, gain unlimitedSHORT sell high first, hope to buy back low, gain capped, loss unlimitedSHORT SALE selling stock you borrowed, not stock you ownSHORT COVER buying it back to return what you borrowedMARGIN CALL the broker asking for more cash, fastSESSION 17 Sell High, Buy Back Low
Every investor learns "buy low, sell high" on day one. Short selling is what happens when someone flips that rule upside down, sells first, buys later, and bets the stock is headed down, not up. It can work. It can also go wrong in a way that regular investing simply can't.
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Background
The Trade That Runs Backwards
Buying a stock is simple: buy it cheap, hope it climbs, sell it for more than you paid. Short selling runs the exact same trade in reverse: you sell first, at today's price, then buy it back later, hoping the price has fallen by the time you do. The catch is that you can't sell something you don't own, so a short seller borrows the shares from a broker first, sells the borrowed shares on the open market, and owes the broker an identical number of shares back later, however the price has moved by then.
Worked example: you borrow 100 shares of a stock trading at $10.00 and sell them immediately for $1,000.00. The price drops to $5.00, so you buy 100 shares back for $500.00, hand them back to the broker, and pocket the $500.00 difference, $5.00 per share. Now imagine the price had gone the other way, up to $15.00 instead. Buying back 100 shares now costs $1,500.00, $500.00 more than you received for selling them. That's a $500.00 loss, out of your own pocket, to close the trade out.
Short selling tends to pay off when a stock, or the whole market, is sliding, a bear market. It's a real strategy real investors use. It's also why most financial advisors reserve it for experienced investors only, and why it doesn't fit a long-term, buy-and-hold savings strategy: you're betting against time instead of with it.
One more wrinkle: money from a short sale doesn't just land in your cash balance and sit there. The position gets "marked to market" at the end of each trading day, its value is recalculated against the latest price. If the price dropped that day, the gain (so far) shows up in your cash balance. If it rose, the loss comes straight out of it, even before you've bought the shares back to close the trade.
For a plain-English refresher outside class, Nasdaq.com's "The Basics of Short Selling" covers the same mechanics in a few short paragraphs.
Key Terms
Vocabulary
Tap a card to flip it and reveal the definition.
Bear Market
A prolonged period of falling stock prices, often measured by a decline of 20 percent or more.
Bull Market
A prolonged period of rising stock prices.
Initial Margin Requirement
The minimum amount of equity an investor must keep in a brokerage account to borrow money or shares for short selling or margin purchases.
Long Position
The plain, ordinary condition of owning stock. Its value is the current share price times the number of shares owned.
Margin Account
A brokerage account that allows an investor to borrow money or stocks from the broker, the account type that makes short selling possible.
Short Cover
Buying stock in order to repay the broker for shares that were borrowed and sold short. This is how a short position gets closed.
Short Sale
The sale of stock borrowed from a broker. The short seller is betting the price will drop, so the borrowed shares can be repaid with cheaper ones.
What You'll Be Able To Do
Objectives
Define short selling and long position.
Develop successful long and short investment strategies.
Explain the advantages and disadvantages of short selling.
Evaluate short selling as an investment strategy.
Calculate real and potential portfolio changes.
Materials: Fact Sheet 1: Selling Short · Activity Sheet 1: Short Selling.
Suggested time: 50 minutes.
The Math That Matters Most
Gains Capped, Losses Endless
This is the one idea to walk away with today. Going long and going short aren't just opposite bets, they have completely different risk shapes. Picture the price of a stock you bought at $20, then picture the same $20 stock, except you sold it short instead.
Gains, capped at 100%Losses, capped at 100%
Own a stock, and the worst thing that can happen is it falls to $0. Painful, but it stops there, you can never lose more than the 100% you put in. The best case, meanwhile, has no ceiling, a stock can climb 2x, 10x, 100x, there's no rule against it. Short a stock, and everything flips. The best case is capped at 100%, the stock falls all the way to $0 and you keep the whole amount you sold it for. But the worst case has no ceiling at all, a stock can climb 2x, 10x, 100x, and every bit of that climb comes directly out of the short seller's pocket.
Same Stock, Two Bets, 100 Shares at $20
Larry buys 100 shares at $20 ($2,000 invested). Harry short sells 100 shares at $20 ($2,000 received). Watch what happens to each of them as the price moves.
Price becomes…
Larry (long)
Harry (short)
$0
−$2,000 (max loss)
+$2,000 (max gain)
$10
−$1,000
+$1,000
$20 (start)
$0
$0
$30
+$1,000
−$1,000
$40
+$2,000
−$2,000
$60
+$4,000
−$4,000
$100
+$8,000
−$8,000
$1,000 (why not!)
+$98,000
−$98,000
Look at that bottom row. It's a silly number for a stock to hit, but nothing in the rules of the market says it can't. Larry's column stops getting worse at $0, it never stops getting better. Harry's column stops getting better at $0, it never stops getting worse. That's the whole lesson, in one table.
Warm-Up
Larry & Harry, Identical Twins, Opposite Bets
Larry and Harry are identical twins, easy to tell apart anyway because they dress and dress up their music taste nothing alike. Both have money in Cake 'n Muffin Corp., a bakery chain currently trading at $22.22 a share. Larry thinks Cake 'n Muffin is a great company on its way up. Harry thinks it's a ridiculous company on its way down, and he still wants to make money on that opinion.
What should each brother consider before deciding on his position? What research would you do before forming an opinion about where a stock is headed?
DiscussionBoth brothers should be looking at the same underlying questions, just reaching different conclusions: is the company growing sales and earnings, how does it compare to competitors in its industry, is it fairly priced relative to those earnings (its P/E ratio), what's happening in its broader industry and the economy, and does recent news suggest momentum in either direction. Useful research includes recent earnings reports, analyst opinions, industry news, and the company's own investor materials, the same homework from Activity Sheet 3 back in Session 16, just aimed at a "will this go down" conclusion instead of a "will this go up" one for Harry.
Fact Sheet 1
Selling Short, Four Steps
Short selling reverses the usual order of the investment process, sell first, buy later. Here's the whole mechanism, broken into four steps:
Step 1
Borrow shares of stock from your broker. Buying shares means they're yours to keep. Borrowing shares means you must return them whenever the broker asks.
Step 2
Sell the borrowed shares on the open market, at whatever the current price is.
Step 3
Wait, and hope the price of the stock drops.
Step 4
Buy back the same number of shares you borrowed, this is the "short cover", and return them to the broker. If the price dropped, buying back costs less than you received, and you keep the difference. If it rose instead, buying back costs more, and you cover that gap out of pocket.
The shares for a short sale come out of a margin account, a special brokerage account that lets an investor borrow money or stock. As a stock's price rises against a short position, the investor's equity in that margin account shrinks. If it shrinks past a set maintenance requirement, the broker issues a margin call, a demand for more cash or securities, right away, not on the investor's schedule.
Procedure
Working Through Larry & Harry
Larry does his research and decides Cake 'n Muffin has real upside, he's going long, buying now and planning to sell later at a profit. Harry disagrees. He thinks the stock is overpriced and headed down, so to make money on that belief, he has to reverse the golden rule and sell high before buying low, short selling.
Q1
Assuming both brothers invest in the same stock, which brother will likely do better in a bull market? Which will do better in a bear market? Why?
DiscussionIn a bull market, rising prices, Larry's long position gains value while Harry's short position loses value, so Larry comes out ahead. In a bear market, falling prices, it flips: Harry's short position gains as the stock he borrowed and sold gets cheaper to buy back, while Larry's long position loses value. Each brother's strategy is a bet on which kind of market is coming.
Q2
What are the advantages and disadvantages of each brother's strategy?
DiscussionLarry's long position has a simple, well-understood risk, he can lose what he paid and nothing more, and it fits a long-term buy-and-hold plan. Its downside is that it only pays off if he's right about the stock rising, and he's fully exposed if it falls. Harry's short position lets him profit even while everyone else is losing money in a downturn, but it comes with unlimited loss potential, ongoing borrowing costs and fees, and the risk of a margin call forcing him out of the trade at the worst possible moment.
Q3
Suppose Larry bought 100 shares of Cake 'n Muffin at $20.00. What's his maximum possible loss?
100 × $20.00 = $2,000, if the stock falls all the way to $0. That's the floor, it can't go any lower.
Q4
If Harry sold the stock short at $20.00 instead, what's his maximum possible loss?
Unlimited. Harry has to replace the borrowed shares no matter what they cost. If the price climbs and keeps climbing, his loss keeps growing right along with it, there's no ceiling. At some point he'll likely decide to cut his losses and buy the stock back to close the trade, but nothing in the market forces the price to stop rising before he does.
Based on what you've learned, if you were investing your own money, could you see yourself short selling? Why or why not?
DiscussionOpen discussion, there's no single right answer. Some students may see the unlimited downside as reason enough to avoid it entirely; others may see a place for it, in small size, as one tool among many, for someone experienced enough to watch the position closely and cut losses fast if it moves the wrong way.
Activity Sheet 1
Short Selling, Two Real Stocks
Pick a financial site with historical stock quotes (Yahoo Finance, Google Finance, or stockanalysis.com all work) and research the two stocks below. Prices move every trading day, so pull live numbers rather than relying on any figure printed here.
Netflix (NFLX)
Look up Netflix's monthly closing prices from September 2011 to September 2012. If you had short sold NFLX during that stretch, would you have gained or lost money? Why? Then look up today's NFLX price and describe the path from September 2011 to today, if you'd bought and held instead of shorting, would that have gained or lost money?
DiscussionThis one has a real story behind it worth knowing before you look up the numbers. In mid-2011 Netflix raised prices by splitting its streaming and DVD plans, then briefly announced (and quickly scrapped) spinning off the DVD business as "Qwikster." Customers and investors revolted, and the stock fell hard through the rest of 2011 before partially recovering in 2012, a textbook stretch for a short seller to have profited in. One thing to watch for when you pull the numbers: Netflix has split its stock twice since this worksheet was written, 7-for-1 in 2015 and 10-for-1 in November 2025, so 2011–2012 prices will look dramatically different from today's unless your data source has adjusted for both splits (most reputable ones do this automatically).
Time Warner Cable (TWC)
Look up TWC's monthly closing prices from September 2011 to September 2012 the same way. Would a short seller have gained or lost money over that stretch?
DiscussionYou can still look up TWC's 2011–2012 prices, that part of the question works fine. But "what's TWC trading at today" doesn't, because there is no TWC stock today: Time Warner Cable was bought by Charter Communications in a deal that closed in May 2016, and it hasn't traded as an independent stock since. It's a good real-world lesson of its own, a company you're short (or long) on can simply stop existing as a standalone stock, through an acquisition, a merger, or a bankruptcy, closing out your position on someone else's timeline instead of yours. For the "what would this look like today" half of the question, pick a currently active company in the same space, cable, media, or streaming, and compare.
Assessment · Application · Enrichment
Putting It Together
Assessment: In your investing journal, track a stock you discussed today. Keep checking in on it: would it have been better to hold it long, or short it, so far?
Application: Suppose you thought a particular stock was about to fall. Discuss with your team why short selling it might be a good idea, and make sure risk gets equal airtime in that discussion, not just the upside. Look at your team's current portfolio: is there any stock you're holding long that you'd now consider short selling instead, using profits you've already banked?
Novice
Given current conditions in the economy, name one stock you might consider short selling and explain your reasoning in a sentence or two.
Apprentice
Name two stocks you'd consider short selling right now, and explain your reasoning for each. What's the biggest risk to each trade going wrong?
Master
For one candidate stock, calculate what a 100-share short position would gain or lose at several different future prices, the way Larry and Harry's table did above, including at least one price where the loss would be painful.
Grand Master
Enrichment: Reverse your team's entire current portfolio on paper, every long becomes a short and every short becomes a long. Show the calculations, then compare your team's actual ranking to the ranking you'd have under the reversed portfolio. Would you be happier with the real portfolio or the reversed one? Then go become the team's short-selling expert: research the actual rules around shorting (margin requirements, borrowing fees, the uptick rule) and present a short tutorial on the mechanics to the rest of the team.