Shorting a Stock: What You Should Know About Short Selling

When it comes to profiting off the stock market, most Canadians make money when the price of stocks go up. But quite a few try to short sell and make money when the value of stocks goes down. How does short selling work, and is it worth the risks involved? 

Here’s what Canadian investors should know about shorting a stock. 

What is shorting a stock? 

When investors short a stock, they borrow shares from other investors, sell them at the current price, and buy them back later when the price of the stock has gone down.

In short, shorting a stock is a bearish position. You’re essentially selling high in the hopes that a stock’s value will go down, then buy it low. This is the opposite of the traditional investor, who holds a long position and bets that the value of a stock will go up over time. 

For example, let’s say you believe Stock A is overvalued at $100 per share. You believe in a short time the price of Stock A will plummet. So, you find an investor through your brokerage who is willing to lend you 100 shares of Stock A. 

After you sell the 100 shares, you’re left with $10,000, along with an obligation to return the 100 shares to their original investor at some point in the future. 

Now, let’s say that after a month, Stock A’s price falls to $50 a share. At this point, you’re in a lucrative position, so you buy 100 shares of Stock A for $50 per share, or $5,000 total. After you return the original 100 shares to their rightful owner, you get to pocket $5,000 ($10,000 – $5,000) — less any commission or transaction fees. 

What are the risks of short selling? 

Shorting a stock could bring you some hefty short-term gains. But it’s a dangerous game to play. Here are some risks to short selling that you should be aware of. 

1. Losses are unlimited 

Normally, when you buy stocks, you have unlimited profit potential with limited losses. At the most, you’ll suffer a complete loss, meaning your stocks will go to zero, and you’ll lose whatever you originally invested. But if your stocks’ values soar, you don’t have to worry about a cap on how much you earn. 

With short selling, the opposite is true. Your gains are capped, and your losses are unlimited. 

Let’s look at Stock A again. You borrow 100 shares of Stock A and sell them for $100 per share. You have $10,000 in your brokerage account, and you wait until the prices go down to repurchase the shares. In this scenario, the most you could ever make happens when the value of Stock A hits zero (Company A goes bankrupt). In that rare event, you could buy 100 shares and pocket your full investment of $10,000. 

However, let’s assume you’re wrong. Let’s assume Company A does well, and Stock A goes up to $200 per share. If you had to return the 100 shares of Stock A here, you’d have to spend $20,000 — $10,000 from your original sale of Stock A and $10,000 of your own money. So, in the end, you’d lose $10,000.

But now, let’s say you didn’t have to return Stock A when it hit $200. Let’s say you were still convinced Stock A would plummet in value. Well, if Stock A’s value continued to rise, your losses would only grow. At $250 per share, you’d lose $15,000. At $300, you’d lose $20,000. At $400, $30,000. And so on. 

It’s this unlimited loss potential that makes short selling so risky. If you guess right, you can make a nice little profit for yourself. But guess wrong, and your losses will depend on your ability to tap out. 

2. You don’t how the market will behave 

No matter how informed you are, your short-selling strategy is essentially a guessing game. Even the most well-informed short stock investors won’t guess the market right, not to mention do it enough to turn a significant profit. 

Take GameStop (NYSE:GME), for instance. Before February 2021, many short-sellers had their eyes on this dying video game retail store. For nearly a decade, GameStop struggled to keep up in a world that preferred digital over physical video games, and stock had been falling. Though a crew of new executives brought stock prices up in January, short-sellers expected GameStop shares to fall again. 

And they might have, if not for Reddit group WallStreetBets. Members of the group noticed investors were short selling GameStop stock. In a move that baffled nearly every investor, these investors performed a short squeeze — they bought stock and drove the price of GameStop stock up. As a result, short-sellers began to lose a large amount of money at an increasing pace. 

The GameStop case may seem like an anomaly. But it illustrates a major risk of short selling: you truly don’t know how the market will behave. Just when you think a company is smoldering in its ashes, a group of investors rekindles the fire. And if you’re on the losing side, your losses put you in a big hole. 

3. You’re borrowing someone else’s stock 

Finally, the shares you borrow aren’t yours, and you have an obligation to return them. If the shareholder who lent you the stocks wants them back, you have to give them back. Period. This could lead you to close your position before you can turn a profit, which means you’ll have to swallow your losses and repurchase their stocks. 

When does shorting a TSX stock make sense?

More often than not, those who are successful at shorting a stock have well-informed reasons for selling high and buying low. For example, they may see a fundamental flaw in the business that will erode its value or hurt its market price, or they could see a bigger industry trend that will likely hurt a particular stock’s value. 

Note: Successful short stock investors typically don’t act on a “hunch.” They’re experienced, and they have good reasons to believe the price investors are willing to pay today is much higher than what they’ll be willing to pay in the future. 

How to short a stock: A step-by-step process

Short selling is a strategy used by more advanced investors who believe a stock’s price is headed lower. Instead of buying low and selling high, short sellers aim to sell high first, then buy back lower to pocket the difference. Here’s how the process works in Canada:

1. Open a margin account

To short a stock, you must open a margin account, which allows you to borrow shares from your broker. This account is different from a standard cash account. It comes with higher risk, interest charges on borrowed funds, and strict collateral requirements.

In Canada, discount brokerages like Questrade, Interactive Brokers, and TD Direct Investing offer margin accounts with shorting capabilities. You’ll be required to meet minimum margin requirements and may be subject to margin calls if the trade moves against you.

2. Locate the stock to borrow

Before placing a short sell order, your broker must locate and lend you the stock. This is called a “locate”.

• Large, liquid stocks like Shopify or TD Bank are usually easy to borrow.
• Thinly traded, volatile, or small-cap stocks may be “hard-to-borrow” and carry extra fees—or may be unavailable altogether.

If the broker can’t find available shares to lend, you won’t be able to execute the short.

3. Place a short sell order

Once the stock is available to borrow, you can place a short sell order through your trading platform. This order instructs the broker to sell the borrowed shares at the current market price.

Example: If Shopify is trading at $90 and you short 100 shares, you receive $9,000 in proceeds—but you now owe 100 shares back to your broker.

4. Wait and monitor the position

After initiating the short, you’re hoping the share price declines. If it drops to $70, you can buy back those shares for $7,000—resulting in a $2,000 gross profit (minus fees and interest).

However, if the stock rises, your losses are potentially unlimited, since there’s no ceiling on how high a stock can go. This is the biggest risk of short selling. You may also face a margin call, where the broker demands more capital to maintain your position.

Other risks include:

• Dividends: If the company pays a dividend during your short, you must pay it to the lender.
• Short squeeze: If too many investors are short and the stock suddenly surges (e.g., due to good news or a squeeze), you may be forced to close the position at a steep loss.

5. Close the short position (buy to cover)

To exit your short position, you must buy back the same number of shares in the open market. This is known as “buying to cover”.

Using the earlier example:

1. Your gross profit is $2,000 (excluding fees and interest).
2. You shorted Shopify at $90.
3. It falls to $70.
4. You buy back the 100 shares for $7,000 and return them to your broker.

Key Considerations for Canadian Investors

• Dividends: If the company issues a dividend while you’re short, you’re on the hook to pay it to the lender.
• Interest and fees: Brokers may charge borrowing fees, especially for hard-to-borrow stocks, in addition to daily interest on margin balances.
• Tax treatment: Short selling profits are taxable as regular income, not capital gains.

Shorting can be profitable, but it’s also risky. Many investors prefer using inverse ETFs or put options to hedge instead of direct short sales.

How to Time a Short Sale

Successfully timing a short sale requires precision, patience, and a solid understanding of both technical and fundamental signals. Shorting too early — before the broader market or other investors recognize the downside — can lead to significant losses as the stock continues rising. Below are key factors to consider when determining the right time to enter a short position:

1. Technical Breakdown Patterns

Chart analysis is one of the most common tools for timing short sales. Traders often wait for a stock to break below a well-established support level, complete a bearish reversal pattern (such as a head-and-shoulders or double top), or show signs of lower highs and lower lows. A breakdown accompanied by high volume adds confirmation that selling pressure is accelerating.

2. Earnings Misses or Negative Guidance

Earnings season is a prime opportunity for short sellers. A disappointing quarterly report, a missed analyst expectation, or a company issuing lower forward guidance often leads to sharp selloffs. These events can signal the beginning of a downtrend, especially if the stock had been priced for perfection prior to the announcement.

3. Overbought Technical Indicators

Timing a short sale can also involve identifying when a stock is technically overbought. Tools like the Relative Strength Index (RSI) above 70, MACD divergences, or parabolic price movements can suggest that the stock is due for a pullback. These setups are best paired with signs of weakening momentum to avoid premature entries.

4. Weakening Fundamentals

Short sellers often look for cracks in a company’s financials. Declining revenue growth, rising debt, shrinking profit margins, or deteriorating cash flow can signal long-term vulnerability. If these issues are not yet priced into the stock and analysts remain overly optimistic, it may present a shorting opportunity.

5. Negative Catalysts on the Horizon

Upcoming regulatory actions, lawsuits, management turmoil, or sector-specific headwinds can act as triggers for downward revaluation. These events are often underestimated until they materialize—providing short sellers with an edge if they position early enough.

6. Wait for Confirmation Before Entering

Jumping into a short position too soon is a common mistake. Many traders wait for confirmation signals, such as a breakdown through support, a failed breakout, or a closing price below a key moving average. Confirming that momentum has shifted downward helps reduce the risk of shorting into a still-rising stock.

7. Use Strict Risk Management

Even with the perfect timing, short selling requires discipline. Use stop-loss orders, position sizing, and capital limits to prevent small losses from becoming unmanageable. Always be prepared for short squeezes or news events that could quickly reverse a bearish setup.

What is the cost to short sell?

Short selling involves several potential costs that investors should consider:

• Margin interest: You pay interest on the value of borrowed shares, typically charged daily by your broker.
• Borrow fees: If the stock is hard to borrow, you may incur additional borrow or locate fees.
• Dividend payments: If the company pays a dividend while you’re short, you must pay the equivalent amount to the lender.
• Commission and trading fees: Standard brokerage commissions or platform fees may apply.
• Margin calls: If the trade moves against you, you may be required to add funds or liquidate your position to meet margin requirements.

These costs can erode profits and increase risk, especially if the position is held long-term.

Is short selling illegal?

No. But in Canada, short selling may see some regulation in the future. That’s because some investors are engaging in certain questionable practices, most notably “short-and-distort” campaigns. In these campaigns, short-sellers will sell borrowed shares of stock, then use social media or other means to publicly attack companies, thereby bringing the stock prices down. When the prices are low enough, they repurchase the shares and profit from the price difference. 

Conversely, some short-sellers will use a “pump-and-dump” strategy, which spreads positive (but false) rumours about a company, raising stock prices momentarily. This gives short-sellers enough time to sell borrowed stock before the prices go back down. 

The Canada Securities Administration (CSA) is well aware of these problems, and they’re working on making new short-selling regulations. 

Check back on this page for more information as regulations are put in place.

Should you short a TSX stock? 

Shorting a stock can be a profitable investing strategy if you’ve identified stocks that will drop in value.

But that’s the trick — you have to be sure a stock’s value will actually decrease. If it doesn’t, your loss has unlimited potential, which could put you out of a lot of money. 

For this reason, you should only short a stock if you’re an experienced investor. Even then, don’t rely on stock shorting alone for your market gains. The best investing strategy (beginner or expert alike) is to invest in great stocks for the long term. If you want to short a stock, do so with caution, but don’t sacrifice any long-term growth for short-term gains. 

FAQs

Is shorting a good strategy?

Shorting can be profitable in bear markets or when a stock is overvalued, but it carries high risk and unlimited downside. It’s best used by experienced investors with strong risk management practices.

How to know when to short sell?

Short selling is typically considered when a stock shows signs of overvaluation, declining fundamentals, or negative momentum. Technical indicators, earnings misses, or macroeconomic headwinds can help signal short opportunities.

What are the skills of short selling?

Successful short sellers need strong analytical skills, deep understanding of valuation, and disciplined risk control. Timing, market awareness, and emotional discipline are also critical to avoid premature entries or forced exits.