Getting started
Borrowed money and borrowed shares can make a good trade look great and a bad trade look catastrophic. Learn how both work — and the math that shows what you actually earned.
About 7 minutes to read, 8 minutes for the quiz. For educational purposes only — not investment advice.
Building block 1 of 4
What it is
Short selling flips the usual order of investing. Instead of buying first and selling later, you borrow shares from your broker, sell them right away, and hope to buy them back (called "covering") at a lower price. You return the shares to the lender and keep the difference.
Why it matters
It is the only way for most investors to profit directly from a stock falling. But the risk is lopsided: a stock can only drop to $0, so your best case is capped at 100% of the sale price — while a stock can rise without limit, so your potential loss has no ceiling. You can lose more than you put in.
What it costs
Shorting needs a margin account. While the position is open you pay a borrow fee (higher for stocks that are hard to borrow), and if the company pays a dividend, you owe that dividend to the person you borrowed from. These costs come out of your profit.
Worked example
You short 100 shares at $50 and receive $5,000. The stock falls to $40, and you buy back 100 shares for $4,000.
Gross profit = (sell price − buy-back price) × shares
= ($50 − $40) × 100 = $1,000
If the stock had risen to $65 instead, you'd owe $6,500 to buy the shares back — a $1,500 loss.
Building block 2 of 4
What it is
Buying on margin means borrowing money from your broker to buy more stock than your cash alone would allow. The stocks you own become collateral for the loan, and you pay interest on whatever you borrow for as long as you owe it.
How much you can borrow
Under the Federal Reserve's Regulation T, you can generally borrow up to 50% of a stock's purchase price — so $10,000 of your own cash can control up to $20,000 of stock. That 2-to-1 ratio is called leverage. Brokers can set stricter limits, and not every stock qualifies.
Why it matters
Leverage multiplies everything — your gains and your losses. The loan stays the same size no matter what the stock does, and the interest keeps adding up whether the trade is working or not. The bigger the loan relative to your own money, the less room the stock has to fall before you're in trouble.
Worked example
You put in $10,000 and borrow $10,000, buying 200 shares at $100 ($20,000 total).
The stock rises 10% to $110. Your shares are worth $22,000. Repay the $10,000 loan and you have $12,000 — a $2,000 gain on $10,000 = 20%, double the stock's 10% move (before interest).
If the stock instead falls 10% to $90, you're left with $8,000 after repaying the loan — a 20% loss.
Building block 3 of 4
What it is
Your equity is what you actually own: the value of your account minus what you owe the broker. Brokers require equity to stay above a maintenance requirement — typically a minimum of 25% of the position's value for a margin purchase, and often higher at your broker. If equity drops below it, you get a margin call: a demand to add cash or securities, fast.
Why it matters
If you can't meet the call, your broker can sell your holdings without asking you — and without caring about the price — to bring the account back into line. That can turn a temporary dip into a permanent loss, and a forced sale can leave you owing money even after everything is sold.
The squeeze risk for shorts
When a heavily shorted stock jumps, short sellers face margin calls and have to buy shares back to close their positions. All that buying pushes the price even higher, forcing more shorts out — a "short squeeze." It is one of the fastest ways to lose money in the market.
Worked example
From the margin purchase above (200 shares, $10,000 loan, 25% maintenance), your equity fraction is (price × 200 − $10,000) ÷ (price × 200).
Margin call price: 200 × P − $10,000 = 25% × (200 × P)
150 × P = $10,000, so P ≈ $66.67
The stock only has to fall about 33% from $100 to trigger the call — even though you started with 50% of your own money in the trade. At a 30% maintenance level, it triggers near $71.43.
Building block 4 of 4
The formula
The stock's percentage move is not your return. Your return is measured against your own money, after paying back the loan and subtracting every cost along the way.
Real return = (ending equity − your starting cash) ÷ your starting cash
Ending equity = sale proceeds − loan repaid − interest & fees
Don't forget the costs
Margin interest accrues daily at a rate set by your broker, so holding longer costs more: interest = amount borrowed × annual rate × (time held in years). For shorts, add the borrow fee and any dividends owed. Commissions and taxes also reduce what you really keep.
Worked example — margin purchase
$10,000 of your cash + $10,000 borrowed buys 200 shares at $100. After six months the stock is $120, and the loan carried 8% interest.
Value: 200 × $120 = $24,000
Interest: $10,000 × 8% × 0.5 = $400
Ending equity: $24,000 − $10,000 − $400 = $13,600
Return: ($13,600 − $10,000) ÷ $10,000 = 36%
The stock gained 20%, so leverage lifted it to 36%, not 40%: interest took four points. If the stock had fallen 20% to $80, ending equity is $16,000 − $10,000 − $400 = $5,600, a 44% loss.
Worked example — short sale
You short 100 shares at $50 ($5,000 proceeds) and post $2,500 of your own cash as the required margin. The borrow fee is 3% a year, for six months, and the stock falls to $40.
Gross profit: ($50 − $40) × 100 = $1,000
Borrow fee: $5,000 × 3% × 0.5 = $75
Net profit: $925, so return = $925 ÷ $2,500 = 37%
If the stock doubled to $100 instead, you'd lose $5,000 — 200% of your $2,500.
Correct!
You just finished the Short Selling & Margin Course — you can now explain how borrowing works and calculate what a leveraged trade really earned.
Certificate of Completion
Short Selling & Margin Course
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Learn to Love Money
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Learn to Love Money is for educational purposes only and does not provide personalized financial, investment, tax, or legal advice. Short selling and margin borrowing are leveraged strategies that can cause losses larger than your original investment, and a broker can sell your holdings without notice. All numbers in the examples are illustrative; real margin rates, borrow fees, and maintenance requirements vary by broker and stock. Nothing on this page is a recommendation to buy, sell, short, or hold any security. Always do your own research and consult a licensed professional before making financial decisions.