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A SHORT, or short position, is created when an INVESTOR or TRADER sells a stock first with the intention of repurchasing it or covering it later at a lower price. A trader may decide to short a stock when he believes the price of that security is likely to decline in the near future.

Short trades can be NAKED  and COVERED. A Short Position NAKED is when a trader or investor sells a stock without having possession of it. However, that practice is illegal in the US, for stocks. A Covered Short is when a trader borrows stock from a stock lending department; in return, this trader pays a borrowing fee during the time the short position is in his hands. In the futures or currency markets, short positions can be created at any time.

A short position refers to a form of trading in which an investor sells a stock for the purpose of buying it back later. A short position is a strategy used when an investor anticipates that the price of a stock will fall in the short term.  In common practice, short sellers borrow shares from an investment bank or other financial institution, paying a fee for borrowing the shares while the short position is in place.

Understanding Short Positions

When creating a short position, it must be understood that the investor has a finite potential for profit and an infinite potential for loss. This is because the profit potential is limited to the distance of the stock at zero. However, a stock could potentially rise for years, making a series of higher highs.

It is also important to understand what a “short-squeeze” is. It is when a stock suddenly begins to rise in price when traders and investors who are short begin to hedge the stock. A famous “short-squeeze” occurred in October 2008, when Volkswagen shares rose sharply because short sellers rushed to cover their stocks. During this short-squeeze period, stocks rose from approximately 200 to 1000 euros in just over a month.

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