Short selling is when an investor effectively bets on the price of a financial asset falling. To do this, the investor borrows a certain number of shares (or some other asset), which will be returned in full at a later date. They can then sell the borrowed shares and purchase the same number back once the price has fallen, thus making a profit. This strategy only works when the share price does fall – otherwise, the borrowed stocks need to be repurchased at a higher price, causing a loss. The risk-reward ratio for short selling is high and, due to this, investors can incur great profits or losses. One of
was the American online used-car retailer company, Carvana, with the majority of its float being shorted by investors.
What are the risks of short selling?
Short selling can carry greater risks than traditional investments, as losses from traditional investments are limited to the initial cost. For example, if someone purchases 100 dollars of shares, the maximum they can lose is 100 dollars. However, as the price of a security can theoretically increase infinitely, potential losses are also uncapped. The quickly changing environment can catch short sellers off guard. For example,
the performance of the S&P 500 has experienced several gains and losses in the span of a few days. While small movements do not have a profound effect in the long term, those betting against a security during a rebound most likely experience a loss. This loss may have been even larger for those shorting leveraged inverse ETFs like SQQQ. These ETFs track the performance of securities or an index and aim to provide returns when the market is falling rather than when the market is rising.
Retail investors and short selling
Emerging technologies have changed traditional investing. Online trading offers wider market access to retail investors. Popular platforms such as
Robinhood have experienced a steady rate of active monthly users following a significant growth period. Meanwhile,
over half of the world's population engages with social media, allowing the rapid spread of information in a globalized online environment. The combination of social media and online trading platforms has immense potential to disrupt the traditional short-selling practice. The online campaign of the ‘WallStreetBets subreddit’ in early 2020, who decided to deliberately cause losses to institutional investors by urging individuals to purchase shares of certain companies being shorted, thus driving up their stock price. The rise in the video game retailer
GameStop’s share price was the most prominent example of this, with a similar campaign also occurring for the
share price of cinema operator AMC. In the case of GameStop, the dramatic rise in the stock price caused by the campaign created losses for institutional investors estimated by some to be as high as 20 billion U.S. dollars in January 2021 alone.
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