Table of Contents

What Is a Short Position? Definition, Types, Risks, and Example

By

James Chen

Updated August 28, 2025

Reviewed by

Gordon Scott

Fact checked by

Ariel Courage

What Is a Short Position?

A short position involves selling a security with the expectation of buying it back at a lower price, aiming for profit if the price drops. Among the strategies available to investors, shorting is best suited for those confident in their prediction of falling prices. Knowing the difference between naked and covered shorts, along with the potential risks like unlimited losses, is crucial before engaging in short selling.

Traders can create short positions anytime in the futures or foreign exchange markets.

Key Takeaways

A short position involves selling a security with the aim to buy it back later at a lower price.
Short selling can lead to potentially unlimited losses if the security price rises instead of falls.
Traders must use a margin account with appropriate permissions to initiate a short position.
The practice of naked short selling is illegal for equities in the U.S. and banned in some countries.
A short squeeze can occur when short sellers are forced to buy back shares at rising prices, sharply increasing the stock's value.

Short Position: Betting that a security will decrease in value. — Investopedia / NoNo Flores

Risks and Mechanics of Short Positions

When shorting, a trader's potential profit is limited, but their potential loss is unlimited. That is because the potential for a profit is limited to the stock's distance to zero. However, a stock could potentially rise for years, making a series of higher highs. One of the most dangerous aspects of being short is the potential for a short squeeze.

A short squeeze happens when a heavily shorted stock's price spikes as traders rush to cover their positions. One famous short squeeze occurred in October 2008, when the shares of Volkswagen surged higher as short sellers scrambled to cover their shares. During the short squeeze, the stock jumped from about €200 to €1,000 in just over a month.

Share price chart of Volkswagen AG, showing steep rise resulting from short squeeze in 2008 — Image by Sabrina Jiang © Investopedia 2022

Setting Up a Short Position: A Step-by-Step Guide

1. Open a Margin Account: Ensure that you have a margin account, as short selling requires borrowing shares, which entails interest and margin requirements.

2. Check for Permissions: Confirm that your brokerage account allows for short selling, which may require additional permissions.

3. Enter Order Details: On your brokerage platform, enter the required details to place a short order, just as you would for a long trade, but with the intent to sell first.

4. Monitor the Trade: Regularly check the security's price and manage your position, being mindful of accumulating interest and margin requirements.

Real-World Example: Shorting a Stock for Profit

A trader thinks that Amazon's stock is poised to fall after it reports quarterly results. To take advantage of this possibility, the trader borrows 1,000 shares of the stock from their stock loan department with the intent to short the stock.

The trader then goes out and sells short the 1,000 shares for $1,500. In the following weeks, the company reports weaker-than-expected revenue and guides for a weaker-than-expected forward quarter. As a result, the stock plunges to $1,300; the trader then buys to cover the short position. The trade results in a gain of $200 per share, or $200,000.

What Is Margin?

In finance, the margin is the collateral that an investor has to deposit with their broker or exchange to cover the credit risk the holder poses for the broker or the exchange. For example, a short position cannot be established without sufficient margin.

In the case of short sales, under Regulation T, the Federal Reserve Board requires all short sale accounts to have 150% of the value of the short sale at the time the sale is initiated. The 150% consists of the full value of the short sale proceeds (100%), plus an additional margin requirement of 50% of the value of the short sale.

How Much Can I Lose on a Short Position?

Short selling occurs when a trader borrows a security and sells it on the open market, planning to buy it back later for less money. Theoretically, the price of an asset has no upper bound and can climb to infinity. This means that, in theory, the risk of loss on a short position is unlimited.

What Is a Short Squeeze?

Short positions represent borrowed shares that have been sold in anticipation of buying them back in the future. As the underlying asset prices rise, investors are faced with losses to their short position. Aside from the pressure of mounting paper losses, maintaining a short position can also become more difficult because, if the price of the underlying asset rises, so does the amount of margin required as collateral to ensure that the investor will be able to buy back the shares and return them to the broker.

When investors are forced to buy back shares to cover their position, it is referred to as a short squeeze. If enough short sellers are forced to buy back shares at the same time, then it can result in a surge in demand for shares and therefore an extremely sharp rise in the underlying asset's price.

The Bottom Line

Entering a short position involves selling a security you don't own, which is legal but highly regulated. Traders initiate a short by selling borrowed shares, hoping to repurchase them at a lower price. This transaction requires a margin account, potentially incurring interest and brokerage fees. It's crucial to understand the risks involved: if the security's price rises, losses can escalate quickly and are theoretically unlimited since there's no upper limit on price. Due to these significant risks and complexities, shorting is typically suitable for more advanced traders and investors who are equipped to handle these challenges.

Article Sources

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FINRA. "Calculating Margin for Day-Trading And Cross-Guaranteed Accounts."

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