Millions of people invest in the stock market on a daily basis. They buy shares in their chosen companies, hold on to those shares for a certain period of time (which could be minutes, hours, days, months or even years) and then sell them, either at a profit (if the price has moved higher) or at a loss (if the price has moved lower).

A much smaller subset of investors sell stocks short, i.e. they sell stock they they don’t have, anticipating that the share price will fall. After a period of time, they buy that stock back, hopefully at a lower price so they can take a profit.

Selling short is not for the faint of heart because it is an inherently risky strategy, much more risky than just buying shares. Why? Because when you buy shares, the most money you can lose is the price you paid for your shareholding. The price of a stock cannot fall below zero after all. Whereas when you sell short, you have to place funds on deposit with you broker to cover adverse upwards price movements. So if the price keeps on moving up after you have shorted the stock, you will need to continue placing more and more funds on deposit (also known as margin) to cover further upward movements. Your risk is therefore unlimited because theoretically the price of a stock could move from ten dollars to a thousand dollars or higher.

One question many people ask about short selling is how you can actually sell something you don’t own in the first place? Simple, you borrow the stock from your broker. There is a cost to doing this however, as typically brokers charge both a lending fee and charge you interest for the length of the borrowing period.

If you are pretty sure that the price of a stock will fall, then short selling is a way to take advantage of that. But don’t do it unless you fully understand the risks and repercussions. Many a foolish investor has ended up losing money from selling short and then getting caught out as prices rise.