In short selling, the investor anticipates that the stock’s price will decline. To execute this strategy, the investor borrows shares from a broker and sells them on the open market. If the stock price drops as expected, the investor can repurchase the shares at the lower price, return them to the broker, and pocket the difference as profit. However, if the stock price rises, the investor faces the risk of potentially unlimited losses, as there is no cap on how high the stock price can go.
Short Example
Example: Suppose an investor believes that Company X’s stock, currently priced at $100 per share, will decrease. They borrow 10 shares and sell them for $1,000. If the price drops to $70, the investor buys back the 10 shares for $700, returns them to the broker, and makes a profit of $300. If the price instead rises to $130, the investor would need to buy back the shares for $1,300, resulting in a $300 loss.