Understanding Short Selling: Why Investors Bet on Falling Prices and How It Can Go Wrong

Most beginners in the capital market think first of buying – but experienced traders know: you can also profit when prices go down. Short-Selling (engl. Short-Selling) enables exactly that. However, this strategy is a double-edged sword. While it serves to hedge positions, losses can theoretically become infinite. Let’s explore how this complex trading strategy works, what opportunities and pitfalls it presents, and whether it is suitable for your portfolio.

The Basic Principle: How does Short-Selling really work?

Short-Selling follows a simple but counterintuitive process. Instead of buying first and then selling, the order is reversed. An investor borrows a security from their broker — for example, a share of Apple or Amazon — and immediately sells it at the current market price. His calculation: the price will fall, and he can buy back the share later at a lower price. The difference between the sale price and the later repurchase price is his profit (minus fees).

The process occurs in four steps:

1. Borrow: The investor borrows shares from the broker
2. Sell: He sells these at the current market price
3. Wait: He waits for a price decline
4. Repurchase: He buys back the shares at a lower price and returns them to his broker

The system only works if the forecast is correct — if the price falls, the trader makes a profit. If it rises, a loss occurs. And here begins the problem.

The unlimited risk: The big difference to long positions

When you buy a stock, your maximum loss is your invested capital. With Short-Selling, it’s different. Theoretically, there is no upper limit to losses. If a Apple share, sold at 150 euros, suddenly rises to 500 euros, the short-seller has already lost 350 euros per share — and the price could go even higher.

This unlimited loss potential is the main reason why Short-Selling is regarded by many as highly risky. Margin calls from the broker can force positions to be closed prematurely, before the investor can realize his full risk — but that also means losses.

Practical examples: speculation vs. hedging

Scenario 1: Pure speculation on falling prices

Imagine you expect Tesla shares to fall soon. The current price is 437 euros. You short a share — borrow it and sell at 437 euros. Your forecast is correct, and the price drops to 400 euros. You buy back the share and return it to your broker. Your profit: 37 euros (minus fees).

But the opposite: if your prediction was wrong and the price instead rose to 500 euros, you would have lost 63 euros. With multiple shares, such movements quickly become significant.

Scenario 2: Hedging — when short-selling makes sense

Suppose you already own 100 Alphabet shares and like them long-term. In the short term, you expect market turbulence. To hedge, you sell short 100 Alphabet shares. If the price drops by 20 euros:

• Your existing portfolio loses: -2,000 euros
• Your short position gains: +2,000 euros
• Net result: 0 euros

You are protected! Conversely: if the price rises by 20 euros, your portfolio gains, but the short position loses — again an offset. This short-selling scenario is called Hedging and is the legitimate, risk-reducing application of the strategy.

The hidden costs of short-selling

Short-selling is expensive. Reality differs greatly from our fee-free examples:

Lending fees: Brokers charge fees for borrowing stocks, which vary greatly depending on availability. Popular stocks are cheaper, scarce stocks are significantly more expensive.

Transaction fees: Selling and repurchasing incur commissions — double fees.

Margin interest: Those engaging in leveraged short-selling pay interest on the borrowed capital.

Dividends: If the shorted stock pays a dividend during the loan period, the short-seller must pay this.

These costs add up quickly and can erode or even wipe out small profits.

When does short-selling make sense, and when not?

Useful application (Hedging):

• To hedge existing long positions
• When a forecast of a price decline is convincing
• Minimal risk through counter-position
• Often used by professional investors and funds

Risky application (pure speculation):

• Pure betting on falling prices without a counter-position
• Unlimited losses possible
• High fee burden
• Timing is extremely important and difficult to get right

Conclusion: Short-selling is a tool, not a strategy

Short-selling and Short-Selling are legitimate financial instruments — but they require strong discipline and clear rules. As short-selling for risk hedging (Hedging) is valuable. As pure speculation with unlimited loss potential, it is dangerous.

The key lies in correct application: Use short-selling to hedge existing positions, not as a standalone bet. Watch out for fees, set clear stop-losses, and never forget that losses are theoretically unlimited. With this mindset, short-selling can become a useful part of a diversified portfolio — rather than an expensive trap.