Let’s say you want to invest in (and short) companies developing coronavirus treatments. You’ve got a good read on the biotech industry and you think Pfizer and Gilead will have success with their clinical trials, but Moderna and Inovio Pharmaceuticals will fail.
In this scenario, you’d buy 100 shares of Pfizer and Gilead and sell 100 shares of Moderna and Inovio short. There’s no minimum or maximum on how long short sellers must wait until covering, but they do need to maintain proper margin levels and pay interest to their broker.
Thankfully, these clinical trials are rapid fire – Moderna, Inovio, and Gilead all flop while Pfizer reports successful results. Moderna and Inovio shares tumble, so you can buy them back on the open market and return them to your broker for a profit.
You sell Gilead for a loss and hold Pfizer for the time being. This trade earns profits on both shorts, a loss on the Gilead investment, and unrealized gains on the Pfizer investment.
So, for example, if you sold short Moderna at $100 a share and bought them back at $90 that means you made $10 profit per share (minus commissions, exchange fees, etc.)
Bottom Line
Short sellers sometimes get a bad reputation, but they have important roles to play. Shorts hammer companies with fraudulent numbers and provide liquidity to otherwise dry areas of the market.
But shorting stocks also comes with specific risks, including the loss of more than your principal. Short sellers are also swimming against the current in bull markets and often subject to vicious rallies in bear markets. Shorting is hard, make no mistake.
But when the market turns on a dime like it did when the coronavirus hit, shorting protects your long-term investments and creates plenty of profit opportunities in the short term.