What Is Short Selling in Trading?
In this article
- How Does Short Selling Work?
- Long vs Short Positions
- Why Do Traders Short Markets?
- Directional Speculation
- Portfolio Hedging
- The True Cost of Shorting CFDs
- 1. Spread and Commission
- 2. Overnight Financing
- 3. Corporate Actions and Dividend Adjustments
- Major Risks of Short Selling
- Asymmetric Loss Profile
- What Is a Short Squeeze?
- Slippage and Market Gaps
- Conclusion
- Frequently Asked Questions
- Browse All Education
Short selling is a trading strategy where an investor speculates on an asset’s price declining, opening a trade with a sell order and closing it later with a buy order to profit from the net drop. When trading derivatives like CFDs, shorting does not require borrowing physical underlying shares; instead, it is a cash-settled agreement tracking the asset's price movement. Because asset prices can rise without a technical ceiling, short selling carries asymmetric risk, requiring strict stop-loss management alongside considerations for overnight financing swaps and dividend debits.
Short selling is a trading strategy that allows you to speculate on an asset’s price falling. The aim is to sell at a higher price and buy back later at a lower price, making a gain from the difference.
Short selling can give traders more flexibility during market downturns, weak corporate earnings or periods of economic uncertainty. It can also be used to hedge existing investments against temporary price falls.
However, short selling carries risks that differ from traditional buying. An asset’s price can only fall to zero, but it can theoretically rise without limit. This means losses on a short position can continue to grow as the market moves higher.
Quick Takeaways
- Understanding what is short selling starts with knowing that it allows traders to speculate on falling prices by opening with a sell order and closing with a buy order.
- Traditional share shorting involves borrowing shares, while CFD shorting allows traders to speculate on price movements without owning or borrowing the underlying asset.
- Short positions may involve spreads, commissions, overnight financing and dividend adjustments.
- Losses on a short position are theoretically unlimited because an asset’s price can continue to rise.
- Careful position sizing and stop-loss orders are important when managing short-selling risk.
How Does Short Selling Work?
Before exploring what is short selling in more detail, it helps to understand that the process is often described as going short or opening a short position.
In traditional share trading, the process usually involves borrowing shares from a broker or institutional lender. The investor then sells those shares at the current market price.
If the share price falls, the investor buys the shares back at a lower price, returns them to the lender and keeps the difference after costs.
How Short Selling Works With CFDs
The process is different when trading Contracts for Difference.
With a CFD, you do not borrow or deliver physical shares. Instead, you enter into a cash-settled agreement with a CFD provider. The two parties exchange the difference between the asset’s price when the position opens and when it closes.
To understand the structure of these products in more detail, read our guide to what is CFD trading.
Shorting with CFDs usually follows three steps:
- Sell to open: You place a sell order at the current market price to open a short CFD position.
- Track the price: If the market falls, your unrealised gain increases. If the market rises, your unrealised loss increases.
- Buy to close: You place a buy order to close the position. The provider then settles the difference in your trading account.
CFDs remove the need to arrange the physical borrowing of shares. However, short positions may still depend on provider availability, liquidity and borrowing limits for certain assets.
Long vs Short Positions
A long position aims to benefit from a rise in price. A short position aims to benefit from a fall.
For a broader explanation of how these approaches work across different market conditions, read our guide to long and short positions.
Feature | Long Position | Short Position |
|---|---|---|
Market outlook | Bullish | Bearish |
Opening order | Buy to open | Sell to open |
Closing order | Sell to close | Buy to close |
Potential gain | Market price rises above the entry price | Market price falls below the entry price |
Maximum loss | Limited to the amount invested for an unleveraged physical asset | Theoretically unlimited |
Dividend adjustment on CFDs | Usually credited | Usually debited |
Market Outlook
A long position reflects the view that an asset’s price may rise.
A short position reflects the view that the price may fall.
Order Sequence
A long trade opens with a buy order and closes with a sell order.
A short trade reverses this sequence. It opens with a sell order and closes with a buy order.
Profit Conditions
A long position may make a gain if the market rises above the entry price.
A short position may make a gain if the market falls below the initial selling price.
Maximum Loss
For an unleveraged physical investment, the maximum loss is normally limited to the amount invested if the asset falls to zero.
A short position has a different risk profile. Because there is no fixed limit to how high an asset’s price can rise, potential losses are theoretically unlimited.
Dividend Adjustments
Long share CFD positions may receive a cash adjustment when the underlying company pays a dividend.
Short CFD positions are normally debited by an equivalent amount. This reflects the effect of the dividend on the underlying share price.
Why Do Traders Short Markets?
Traders generally use short positions for two reasons: speculation and hedging.
Directional Speculation
Speculative short selling aims to benefit from weakness in shares, indices, commodities or currencies.
A trader may open a short position after identifying:
- a technical breakdown
- weak corporate results
- deteriorating economic conditions
- an asset that appears overvalued
- a negative change in market sentiment
Falling markets can sometimes move quickly and experience sharp volatility. This may create short-term opportunities, but it also increases the risk of rapid losses and slippage.
Portfolio Hedging
Short positions can also be used to reduce the effect of a temporary market decline on an existing investment portfolio.
For example, suppose you hold a portfolio of UK blue-chip shares and expect the broader market to fall. Selling the shares may trigger transaction costs or tax consequences.
Instead, you could open a short position on a stock index CFD with a similar level of exposure.
If the index falls, gains from the short CFD may partly offset the decline in the value of the share portfolio. Once market conditions stabilise, the hedge can be closed while the underlying investments remain in place.
A hedge may reduce risk, but it does not remove it entirely. Poor position sizing or an imperfect match between the hedge and the portfolio can still lead to losses.
The True Cost of Shorting CFDs
Short selling is not free. Since what is short selling always involves ongoing costs beyond the initial trade, it is worth understanding these charges before opening a position.
1. Spread and Commission
The spread is the difference between the Bid price and the Ask price.
When opening a short position, you sell at the Bid price. When closing it, you buy at the Ask price. This means the spread creates an immediate trading cost.
Some Direct Market Access accounts may offer narrower spreads but charge a separate commission for each trade.
2. Overnight Financing
If you keep a leveraged CFD position open beyond the provider’s daily cut-off, an overnight financing adjustment may apply. This is often known as a swap or overnight fee, a cost structure explained in the FCA's guidance on contracts for difference.
The financing treatment of a short position may depend on:
- the relevant benchmark interest rate
- the size of the position
- the broker’s administrative charge
- the asset being traded
- the length of time the position remains open
In theory, a short position may earn interest because it represents cash proceeds from a sale.
However, the broker normally applies a financing margin or administrative fee. This means the position may still incur a daily charge.
If benchmark rates are high, some short positions may receive a net financing credit. If rates are low or the provider’s charge is higher than the benchmark rate, the account may be debited instead.
In practice, many traders assume going short automatically yields positive interest adjustments due to receiving short-sale proceeds. However, after accounting for the broker's daily financing markup, holding a short position over weeks can steadily erode profits—making long-term position shorting far more expensive than expected.
3. Corporate Actions and Dividend Adjustments
If you hold a short share or index CFD across an ex-dividend date, your account may be debited for the dividend amount.
A company’s share price often falls by approximately the value of the dividend on the ex-dividend date. Without an adjustment, a short position could benefit from this mechanical price fall.
To account for this, the CFD provider normally applies a cash debit to the short position. The amount is usually deducted from the trading account on or around the ex-dividend date.
Major Risks of Short Selling
Short selling offers flexibility, but it also creates risks that require careful management. Because what is short selling ultimately comes down to managing an asymmetric risk profile, understanding these risks is essential for anyone considering opening a position.
Asymmetric Loss Profile
The potential gain on a short position is limited because an asset’s price cannot fall below zero.
The potential loss is theoretically unlimited because the price can continue to rise.
Maximum potential gain:
Entry price − £0.00
Maximum potential loss:
Entry price − an unlimited future price
For example, if you buy a physical share at £50, the maximum loss is £50 if the share price falls to zero.
If you short the same share at £50, the price could rise to £100, £150 or more. Your losses continue to increase until the position is closed or the broker liquidates it because of insufficient margin.
What Is a Short Squeeze?
A short squeeze happens when an asset with a large number of short positions rises sharply.
This may be caused by positive news, better-than-expected earnings or a sudden change in market sentiment.
The process can develop quickly:
- Short sellers begin closing their positions by placing buy orders.
- The increase in buying demand pushes the price higher.
- Rising prices trigger more stop-loss orders and margin calls.
- Additional short sellers are forced to buy back their positions.
- The resulting demand can drive the price higher again.
Experienced traders know that short squeezes occur with far greater speed and volatility than standard bullish rallies. Entering a short position without a predefined, hard stop-loss order risks exposing your account to catastrophic slippage during an aggressive squeeze.
Slippage and Market Gaps
During major economic announcements or after markets reopen following weekend events, prices can gap from one level to another.
If the market gaps above a short position’s stop-loss level, the order may be filled at the next available price rather than the selected stop price.
This can create negative slippage and a larger loss than expected.
A standard stop-loss does not guarantee the execution price. Some providers offer Guaranteed Stop-Loss Orders, although these may involve an additional charge.
Conclusion
Understanding what is short selling helps traders decide when speculating on falling markets or hedging existing investments against temporary declines makes sense.
Short selling allows traders to speculate on falling markets or hedge existing investments against temporary declines.
With CFDs, traders can open short positions without borrowing physical shares. They sell to open the position and buy to close it, with the final gain or loss based on the difference between the two prices.
However, short selling carries significant risks. Potential losses are theoretically unlimited, while spreads, overnight financing, dividend adjustments, market gaps and short squeezes can all affect the final result.
Traders should use careful position sizing, understand the full cost of holding a short position and consider using stop-loss orders to manage risk.
FAQ
How do you make money from short selling?
You make a profit from short selling if the market price of the asset drops below your initial entry price. When shorting via CFDs, you execute a "Sell to Open" order at the higher price and later a "Buy to Close" order at a lower price. The positive price difference between your entry and exit is settled into your cash trading account, minus any applicable trading fees, commissions, or daily overnight financing swap charges.
What is the main difference between physical stock shorting and CFD shorting?
Traditional physical stock shorting requires a broker to locate and lend physical equity shares to the investor, who sells them on the open market and incurs a stock borrowing fee. In CFD shorting, no physical shares are borrowed or transferred. Instead, you trade a cash-settled derivative contract directly with your provider, speculating purely on the underlying price movement without administrative locate delays.
What happens if an asset price goes up after you open a short position?
If the market price increases after you open a short position, your trade accumulates an unrealised loss. Unlike long positions where losses are limited to your invested principal if a stock falls to zero, rising prices have no theoretical ceiling. If prices continue to climb, compounding losses will draw down your margin, potentially triggering a margin call or automatic position stop-out if you do not close the trade or add funds.
Do you have to pay dividends when shorting stock CFDs?
Yes. If you hold a short stock or index CFD position past the ex-dividend date, a cash dividend adjustment is debited directly from your trading account balance. Because the underlying share price drops by approximately the dividend payout value on the ex-dividend morning, this automated debit neutralises the artificial drop in price and prevents short sellers from securing an unearned price profit.
What is a short squeeze and how does it affect short sellers?
A short squeeze occurs when a heavily shorted asset experiences a sudden, sharp price rally. As prices rise, short sellers are forced to buy back shares or derivative contracts ("Buy to Close") to cut their losses or satisfy margin calls. This sudden influx of buying volume accelerates the upward price momentum even faster, triggering further stop-loss liquidations and causing severe, rapid losses for unhedged short sellers.
