Most investors make money when shares rise. Shorting is the opposite: a way to profit from a falling share price. It is a common tool for professional investors, but the risk is very different from ordinary share purchases. Even if you never short yourself, it is useful to understand how it works, because short positions can affect the prices of shares you own.
How a short sale works
- You borrow shares from another investor through your broker and pay a lending fee.
- You sell the shares at today’s price.
- Later you buy the shares back and return them to the lender.
If the price has fallen, you buy back more cheaply than you sold, and the difference is your gain. If the price has risen, you must buy back at a higher price, and the difference is your loss.
A worked example
You borrow and sell 100 shares at NOK 200, NOK 20,000 in total.
| Outcome | Buyback | Result before costs |
|---|---|---|
| The price falls to NOK 150 | NOK 15,000 | Gain of NOK 5,000 |
| The price rises to NOK 250 | NOK 25,000 | Loss of NOK 5,000 |
| The price rises to NOK 400 | NOK 40,000 | Loss of NOK 20,000 |
On top of this come the lending fee, brokerage and any dividends paid while you have borrowed the shares, which you must pay to the lender.
Why the risk is so high
When you buy a share, the most you can lose is what you invested, because the price cannot fall below zero. When you short, it is the other way round. The gain is limited to the price falling to zero, but there is no upper limit to how high the price can rise. The loss can therefore in theory be unlimited.
Shorting also requires collateral. If the price rises, you must post more collateral, and if you cannot, the broker may buy back the shares for you at a poor price.
Short squeeze
A short squeeze happens when the price of a heavily shorted share starts to rise. Short sellers must buy back to limit their losses, and these purchases push the price even higher. It can become a self-reinforcing spiral where the price rises sharply in a short time, often without anything fundamental having changed in the company.
The risk of a squeeze is greatest when a large share of the stock is shorted, and when the stock trades thinly. It then takes a long time for short sellers to buy their way out.
What the short interest can tell you
Short sellers have often done thorough analysis and believe the company is overvalued or has problems the market has not priced in. A high and rising short interest can therefore signal that professional investors are sceptical.
At the same time, a high short interest can be part of a hedging strategy, for example where an investor owns one share and shorts another in the same industry. And as mentioned, high short interest raises the risk of a sharp rise in a squeeze.
Rules and disclosure
Short selling is regulated by EU short selling rules. Investors must notify the Financial Supervisory Authority of Norway when a net short position in a Norwegian company reaches a certain share of the stock, and positions of 0.5 per cent or more are published. So-called naked short selling, selling shares without having secured a loan of them, is largely prohibited.
Should you short?
For most private investors, the answer is no. Shorting requires close monitoring, collateral and the ability to absorb large losses quickly. If you want to reduce risk in your portfolio, it is usually simpler to sell or reduce positions, or to diversify better.
Next steps
- See the Oslo Børs price list
- Read about diversifying your portfolio
- Read how AksjeNet calculates scores and signals