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Nasdaq Newsroom

Markets

How Does Short Selling Work? What You Need to Know

May 14, 2026 — 09:00 am EDT

Written by

Nasdaq Newsroom

Nasdaq Public Policy this month released a new Short Selling Resource Hub, which provides market participants with information they need to know about short selling – including the market data landscape and the regulatory protections that safeguard the securities market.

But even the basics of short selling are more complex than the typical buying and selling of securities. Read on for a primer on everything you need to know about how short selling works.

Why Does Short Selling Matter?

Short selling is one of the most misunderstood yet essential concepts in financial markets. Instead of the traditional approach to profiting in the market by buying low and selling high, short sellers reverse the process: they sell high first, then aim to buy back later at a lower price. This is typically done by borrowing shares, selling them on the open market, and eventually repurchasing them to return to the lender. If the price falls as expected, the short seller keeps the difference as profit; if it rises, they will record a loss.

Importantly, short selling is also used by market makers to provide intra-day liquidity and by investors to hedge positions in equities, futures, options and convertible securities.

Shorts sales play a crucial role in how markets function, including by enhancing price discovery, facilitating capital formation, and providing liquidity. Short sellers often act as a counterbalance to excessive optimism: Without short selling, markets could become more prone to bubbles, as there would be fewer mechanisms to identify and correct overvalued assets.

For anyone interested in the markets, short selling is more than just a sophisticated trading strategy: It is a lens through which to better understand markets and risk.

What is the Definition of Short Selling?

At its simplest, short selling is selling a security you don’t already own.

Short selling is a trading strategy used by investors to profit from or hedge against a stock price decrease. Unlike traditional investing, where you buy low and sell high, short selling involves selling borrowed shares at a high price with the goal of buying them back later at a lower price.

If the price of the stock falls, the short seller profits between the higher sale price and lower buy price.

Importantly, not all short sales are bets against a company. Short sales are used to hedge against long positions, options, futures, and convertible securities like bonds or warrants. Hedging is a risk management strategy that involves taking a position in one investment to offset a potential loss in another. Short sales are also used by market makers to provide liquidity to the market. For example, if a market maker sells put options to an investor, they gain positive exposure to the stock (similar to being long shares) and may short the underlying stock to maintain a neutral position.

Short selling is beneficial to markets by contributing to price discovery and market liquidity, ensuring stock prices reflect their true value faster.

How Short Selling Works: Step-by-Step

Short selling is selling shares that an investor does not yet own. In a typical short sale, an investor would:

- Locate and Borrow: The investor identifies a stock or security and locates shares to borrow from a broker. Typically, investors borrow shares in the lending market through their brokerage firm. Lenders can be retail brokers or institutions such as index funds or ETFs, and they typically collect a fee for loaning stock. Stocks in large indexes like the Russell 3000 or S&P 1500 generally have more shares available for lending.

- Sell: The borrowed shares are sold on the open market at the current price.

- Deliver & Cover: The investor later buys the shares back (which they hope will be at a lower price) to return them to the lender. This "closing" of the position is called "buying to cover.”

The Risks of Short Selling

- Unlimited Loss Potential: In the normal process of purchasing equity shares, the worst that can happen is for the price to fall to zero, wiping out the full amount you paid for each share. With short selling, however, if the price of a stock keeps going up, the short seller could face mounting losses with no upper bound. In other words, if a short seller sells a borrowed share at $10, but the price rises to $500, they would then need to take a $490 loss to close out their position.

- Margin Requirements: Brokers typically require investors to maintain collateral in