Module 7 · Lesson 3 of 7 · Stocks and ETFs · About 5 minutes
Short Selling Explained: Borrowing, Fees and Short Squeezes
On this page
- What you will learn
- How does a short sale work?
- Short sale diagram
- What does it cost to borrow shares?
- Why is shorting riskier than buying?
- What are short interest and days to cover?
- What is a short squeeze?
- What this does not tell you about short selling
- Method in Practice
- Check yourself
- Reflect on your own process
- Sources
Before you read: Premarket and After-Hours Trading: Extended Hours Explained
What you will learn
- How short selling a stock works, step by step.
- What borrow fees, short interest and days to cover measure.
- Why short positions carry risks that long positions do not, including a short squeeze.
How does a short sale work?
How can you sell something you do not own?
A short seller borrows shares, sells them, and later buys the same number of shares back to return to the lender. The result is the sale price minus the buyback price, minus fees and any dividends owed.
Example with round numbers. A trader borrows and sells 100 shares of a fictional stock at $40, receiving $4,000. Later the trader buys 100 shares back:
- at $30, for $3,000: a $1,000 gain before costs;
- at $55, for $5,500: a $1,500 loss before costs.
The steps run in the opposite order to buying a stock, which is why a short position is said to be short and a bought position long.
Short sale diagram
Illustrative diagram constructed for teaching. Not real market data.
The diagram shows the four steps of a fictional short sale at $40 and a line showing the result before costs for buyback prices from $20 to $60. The loss side keeps rising as price rises. It is constructed for teaching and is not real market data.
What does it cost to borrow shares?
If shares are hard to find, what happens to the price of borrowing them?
Shares are lent by brokers, funds and other holders. Short selling in most accounts requires a margin account, and the short seller pays:
- A borrow fee, usually an annual rate charged daily. Widely held stocks are often cheap to borrow. Hard-to-borrow stocks can carry very high rates, which can change daily.
- Any dividends paid while the position is open. The short seller owes them to the lender.
- Interest and margin requirements set by the broker and by regulators. If the stock rises, the broker can require more collateral, and can close the position if it is not provided.
The lender can also recall the shares, which can force the short seller to buy them back at an inconvenient time.
Why is shorting riskier than buying?
How high can a stock price go?
A buyer of a stock can lose at most what they paid, if the price falls to zero. A short seller’s loss has no fixed limit, because the price has no upper limit. That difference is the heart of short-selling risk. Gaps make it worse: a stock can open far above the last close after news, past any stop order, so a planned exit may fill much higher.
What are short interest and days to cover?
How could you measure how crowded the short side of a stock is?
- Short interest is the number of shares sold short and not yet bought back. In the United States, brokers report short positions to FINRA twice a month, and FINRA publishes the totals about seven business days after each reporting date. It is often shown as a percentage of the float, the shares available to trade.
- Days to cover is short interest divided by average daily volume. It estimates how many days of normal trading it would take for all short sellers to buy back.
High short interest shows disagreement, not a forecast. It can stay high for a long time.
What is a short squeeze?
If many short sellers need to buy at once, who sells to them?
A short squeeze happens when a rising price pushes short sellers to buy back, through losses, margin calls or recalled shares, and their buying pushes the price higher still. Squeezes can be fast and large and can reverse just as quickly. Describing a squeeze after the fact is easy; knowing in advance whether one will happen is not.
What this does not tell you about short selling
- Rules differ by country and broker. Some markets restrict short selling at times of stress, and under SEC Rule 201 of Regulation SHO, short sales in a US stock face a price test for the rest of the day and the next day after it falls 10% or more in one day.
- Borrow availability and fees can change daily.
- Tax treatment of short sales can be complex. Ask a tax professional about your own situation.
- Nothing here suggests shorting, or avoiding, any stock.
Method in Practice: borrow first, and size for a squeeze
Fictional example. John, Harbor Index futures, the prices, times, costs and results are all invented for teaching. This shows how a written plan can be built and tested. It is not a recommendation, and nothing here says how often this idea works.
Try it on a real chart. Test this idea yourself on past sessions with bar replay. Keep your own count, including the days with no trade.
The idea. A short sale needs shares to borrow, borrow fees change daily, and price can jump past a buy stop (this lesson). John's short plan checks the borrow before anything else, and uses half his normal share count because a squeeze can blow through his stop.
John's plan
- Setup
- Pinecrest Tools fails twice at $30.50. Borrow confirmed, fee under 5% a year
- Enter if
- a 15-minute bar closes below $30.05 after the second failure. Short 100 shares
- Wrong if
- price trades at $30.60 (buy stop)
- Manage
- cover half at $29.20, the rest at $28.60, or within 2 days
- Risk
- $150 maximum. Planned loss about $63, half the normal size because of squeeze risk
Three outcomes
-
Worked: down to both targets over 2 days → +$106.50 after the borrow fee
-
Squeeze: a headline jumped price past the stop → −$114.25. At 200 shares it would have been −$226
-
No trade: no shares available to borrow → $0
Show the full replays
| Replay | What happened | John | Result after costs |
|---|---|---|---|
| A | Locate OK, fee 3%/year. Bar closes $30.02 | Shorts 100 at $30.00. Covers 50 at $29.20 and 50 at $28.60 (limits) over 2 days | +$40 + $70 − $3 orders − $0.50 fee = +$106.50 |
| B | Shorts 100 at $30.00. A headline moves price from $30.20 to $31.10 in one minute | Buy stop at $30.60 fills at $31.12 | −$112 − $2 − $0.25 fee = −$114.25 (planned −$63; inside the cap because of the half size) |
| C | Second failure at $30.50, but the broker shows no shares to borrow | No short possible | $0 |
Test it yourself
- Log the borrow availability and fee on every day you test, not just the days you'd trade.
- Replay the largest one-minute jumps in your sample through your buy stop.
- Check the short-sale rules that apply where you trade (this lesson's Rule 201 note).
Where it breaks
- A buy stop can fill far above its price in a squeeze.
- Borrow can be withdrawn, and fees can rise while you're short.
- Some markets restrict short selling during stress.
Reflection question: If your short gapped 4% against you, would your size still fit your cap?
Check yourself
- A trader shorts 50 shares at $80 and buys them back at $70. What is the result before costs? Hint: (80 − 70) × 50.
- Why does a short position have no fixed maximum loss? Hint: is there a ceiling on price?
- Short interest is 6 million shares and average daily volume is 2 million. What is days to cover? Hint: divide.
Reflect on your own process
- If your plan allows short positions, what written rule caps the loss on one, and how do you handle gaps?
- Where would you check the date and source of a short interest figure before writing it in your journal?
- Which costs of holding a short position does your journal track, and which have you left out?
- If your short gapped 4% against you, would your size still fit your cap?