Recently, someone asked me what short selling is, and in fact, this is an important concept that many beginners tend to overlook when entering the stock market.

Simply put, short selling is borrowing stocks from a broker to sell them short. Imagine you believe a certain stock will decline, but you don't own the stock. At this point, you can borrow the stock from the broker, sell it immediately, and then buy it back after the price drops to return to the broker. The difference between the selling price and the buying price is your profit. This operation is essentially shorting.

Taking Apple stock as an example, if you short-sell 100 shares at a closing price of $191.17 on August 3, and then buy them back at $181.99 on August 4, you make a profit of $918. Theoretically, it sounds good, but there are actually many costs and risks involved.

First, you need to understand the hidden costs behind the question of what short selling is. The annual interest rate for short-term borrowing in Taiwan stocks is usually between 0.1% and 0.4%, while in U.S. stocks, the difference can be much larger, sometimes exceeding 100%. Besides interest, you also need to pay securities transaction tax and handling fees. In Taiwan stocks, the transaction tax is 0.3% of the transaction amount, and the handling fee is about 0.1425%. Some brokers may also charge additional borrowing fees. More importantly, you need to provide margin collateral, which is about 90% of the short position's market value in Taiwan stocks. These costs may seem low, but for short-term traders, they can accumulate into a significant burden over time.

Then there are the risks. The biggest risk of short selling is called a short squeeze. When many people are shorting the same stock, if the stock price rises instead, these short sellers will be forced to buy back at a loss to cut their losses, which can push the stock price even higher, creating a vicious cycle. The GameStop incident in early 2021 is a classic example. At that time, the short interest was extremely high, and the stock price was driven up wildly, causing many short investors to suffer heavy losses.

In addition to short squeezes, there is the issue of forced buy-ins. Since short selling involves borrowing stocks from the broker, when the company holds a shareholder meeting or issues dividends, a shareholder register must be prepared. The broker will then require you to buy back the stock before a specified date. In Taiwan stocks, there are about two mandatory buy-in days each year, before the shareholder meeting and before the ex-dividend date. Around March each year, you should pay special attention, as May and June are the peak times for shareholder meetings. If you do not buy back the stock before the deadline, the broker will close your position at the market price.

Furthermore, if the stock you short continues to rise, your account's margin may fall below the broker's maintenance margin requirement. At this point, the broker will require you to top up your margin. If you fail to do so within the specified time, your short position may be forcibly liquidated, and you will bear all the costs.

So, what is the purpose of short selling? Considering these costs and risks, I do not recommend most people hold short positions for the long term. However, there are two relatively feasible strategies.

The first is to coordinate with earnings reports or major event disclosures. If you anticipate that Apple’s upcoming earnings report will be poor, or that new product launches will disappoint, you can short the related stocks in advance, and then close the position for profit after the price drops. But the risk is that if the earnings beat expectations or the new product exceeds expectations, the stock price may gap up sharply, causing significant losses for short investors. Therefore, it’s crucial to control your position size and monitor the stock price closely.

The second is to use short selling as part of a hedging strategy. For example, if you are bullish on a certain oil and gas stock but worry that the entire energy sector might decline and drag down your portfolio, you can buy the stocks you like and simultaneously short-sell other underperforming oil and gas stocks to hedge the risk. When doing this, ensure that your long and short positions are balanced, and consider the correlation of volatility between the two stocks. If necessary, you can short multiple stocks to build a more balanced hedge portfolio.

In summary, although short selling sounds very attractive, it is definitely not suitable for retail investors to operate long-term. If you really want to try, make sure to clarify all fee details with your broker, control your risks, and don’t let short-term profit opportunities cloud your judgment.