When people talk about investing, including energy investing, they’re almost always talking about going long, where the goal is to buy low and sell high. But you can also profit when the price of a security falls, known as being short, or shorting.
The idea is still to buy low and sell high, only you do it in reverse, selling shares you borrow at a high price, and then buying when the price falls, profiting from the difference.
Short selling involves the selling of a stock that you don’t own. When you short a stock, your broker lends you shares, either from its inventory or from shares it borrows from other clients that have margin accounts. You sell the borrowed shares short, and the proceeds are credited to your account. Eventually, you have to close the short by purchasing the same number of shares. This is called covering.
If the price drops as you expected, you buy it back at a lower price and profit from the difference. But if it rises, you have to buy it at a higher price, and you lose money.
You can usually hold a short position for as long as you want. Sometimes, however, you can be forced to cover if the lender wants the borrowed stock back. This is known as being called away, and you can lose out on potential profits if it happens. You must also pay the lender any dividends or rights declared while the short is open.
If you sold short 11 shares of Exxon at $88.50, and the stock falls to $80.50, you’d buy to cover at that lower price and earn a profit of $8 per share, or $88, minus any commissions or dividends issued while the position was open. If you cover higher than $88.50, you lose money. You can see these results in the table.
| Falling Price | Amount | Rising Price | Amount |
|---|---|---|---|
| Borrowed 11 shares of XOM at $88.50 | $973.50 | Borrowed 11 shares of XOM at $88.50 | $973.50 |
| Bought back (covered) at $80.50 | –$885.50 | Bought back (covered) at $96.50 | –$1,061.50 |
| Your profit | $88.00 | Your profit | –$88.00 |
You can use market, limit, and stop orders for selling short and buying to cover. Just be aware that they work exactly in reverse because you want to sell high and buy low.
