Is shorting a stock a good idea?

Betting against a company can work both ways

Selling a stock short, or “shorting,” is certainly a way to bet against a company’s success. I generally advise most investors to avoid shorting, but if you do decide to short a stock, here’s what you need to know first.

When you short sell a stock, you’re borrowing the shares from your brokerage and selling them on the open market at today’s price. The idea is that when the stock goes down, you can buy the shares back later for a lower price, give them back to your broker and pocket the difference.

As an example, Snap trades for about $22 as I write this. If you were to short sell 100 shares of Snap for $2,200 and the stock falls to $15, you can buy those 100 shares back for $1,500 and the $700 difference is your profit.

However, the risk with shorting a stock is the unlimited loss potential. If you short a stock and it goes up, there’s no limit to how high it can go. At some point, you’ll need to buy back the shares you borrowed.

Let’s say Snap has a blowout quarter, and the price shoots up to $50. You’re now on the hook for buying 100 shares for $5,000. If the stock continues to skyrocket to $100, you’ll need to come up with $10,000 to close the trade.

The bottom line is that if you do short a stock, you need to have a predetermined exit strategy in mind — specifically, a point where you admit you were wrong and take a loss.