How to Short a Stock on Robinhood

Short selling allows traders to profit from falling stock prices, but it’s not without its complexities and dangers. In this guide, we'll delve into the step-by-step process of shorting a stock on Robinhood, along with the associated risks, requirements, and tips to ensure you have a full understanding of the mechanics. We'll also break down some real-life examples and historical cases to give you a broader view.

What is Short Selling?

Before diving into the “how-to,” let’s define what short selling actually means. Unlike buying a stock—where you’re hoping the price will increase—short selling involves borrowing shares of a stock you don't own and selling them at the current market price. Later, you’ll need to buy back the shares to return to the lender, hoping to repurchase them at a lower price to profit from the difference.

Short selling can be tricky. If the stock price goes up instead of down, you could face unlimited losses. You’re essentially betting against the company’s performance or the overall market. And while Robinhood allows you to execute short sales, there are specific steps and qualifications involved.

How Does Shorting Work on Robinhood?

1. Open a Margin Account

Robinhood offers a feature known as Robinhood Gold, which is their margin trading service. To short stocks, you must have a margin account because you're borrowing the stock. Keep in mind that margin trading carries extra risk. You can borrow money or securities from Robinhood to trade, but you’ll also be required to maintain a certain minimum balance in your account, known as the minimum margin requirement.

• Eligibility Requirements: To open a margin account on Robinhood, you need at least $2,000 in your account. This amount can vary based on different regulations, but this is a common industry standard.
• Interest: Robinhood charges interest on any money borrowed through margin trading. This can eat into your profits if your short position doesn’t play out quickly.

2. Enable Short Selling

Once your account is set up for margin, you can now engage in short selling. However, you must first confirm that Robinhood has the shares available to borrow. This is because when you short a stock, you're borrowing shares, not buying them. Robinhood must have enough available inventory to lend to you for the short sale.

3. Place a Short Sale Order

Here’s how the process works:

• Search for the Stock: First, you need to identify the stock you want to short. Using Robinhood’s search bar, enter the ticker symbol or the stock’s name.

• Analyze the Stock: Look at technical charts, historical performance, and key financial metrics to justify why you think the stock will decline. Make sure you do thorough research before entering a short position.

• Sell the Stock (Even If You Don’t Own It): Unlike a regular trade where you "buy" shares, with short selling, you’ll go straight to the "Sell" button on the stock’s page. Robinhood automatically knows you're selling without owning the shares and will process it as a short sale.

• Monitor and Manage Your Position: Keep a close watch on your short position because, unlike holding a stock, where your losses are limited to your initial investment, short selling carries potentially unlimited losses. If the stock price rises significantly, you could be forced to buy back the shares at a much higher price.

4. Buy Back the Stock (Cover Your Short)

Once the stock price falls to your desired level, you can buy back the stock to cover your short position. This is referred to as “covering.”

• Cover Price: Ideally, you want to buy back the stock at a lower price than where you sold it. For example, if you sold the stock at $100 per share and bought it back at $80, your profit would be the $20 difference minus any fees or interest.

• Risks: If the stock price increases instead of decreases, your losses can be limitless. Unlike buying a stock, where you can only lose what you've invested, shorting a stock means you could lose much more than your initial position if the stock price soars.

Example of Short Selling

Let’s walk through a simple example:

• Step 1: You believe Stock XYZ, currently priced at $50, will decrease due to poor earnings forecasts.
• Step 2: You borrow 100 shares of XYZ and immediately sell them for $5,000.
• Step 3: XYZ drops to $40. You now repurchase the 100 shares for $4,000.
• Step 4: You return the 100 borrowed shares and pocket the $1,000 difference, minus fees and interest.

In this case, your profit is the difference between the price at which you sold the stock and the price you repurchased it, minus any borrowing costs.

Risks of Shorting Stocks

While shorting can be profitable, it’s incredibly risky:

1. Unlimited Losses: If the stock price goes up instead of down, you face theoretically unlimited losses. For example, if a stock you shorted at $10 rises to $100, you would owe $90 per share.

2. Margin Calls: If the stock price rises significantly, your broker (Robinhood, in this case) may issue a margin call, forcing you to add more cash or securities to your account to maintain the required margin balance.

3. Borrowing Costs: You’re borrowing the stock from Robinhood, and this comes with interest. The longer you hold your short position, the more you’ll owe in borrowing costs, which can cut into your profits.

4. Stock Dividends: If the company issues dividends while you have a short position, you’ll be responsible for paying those dividends to the lender, adding another layer of cost.

Short Squeeze: A Potential Nightmare

One major risk when shorting stocks is the short squeeze, a situation where a heavily shorted stock experiences a rapid price increase. Short sellers, panicking to limit their losses, rush to buy back shares, causing the stock price to surge even further. This can lead to substantial losses for those shorting the stock.

One of the most famous short squeezes happened in early 2021 with GameStop (GME). A group of retail traders from Reddit's WallStreetBets community began buying GameStop shares en masse, forcing institutional short sellers to cover their positions, leading to a massive price spike.

What Makes Robinhood Unique for Short Selling?

1. No Commission Fees: Robinhood is known for its zero-commission trades, which makes it an attractive platform for retail investors. However, short selling on margin can still incur borrowing fees and interest.

2. Easy Interface: Robinhood’s user-friendly interface makes it simple to execute trades, including short sales. Even for beginners, the platform simplifies the process.

3. Limited Borrowing Availability: One drawback of using Robinhood for short selling is that its borrowing inventory can be limited. If Robinhood doesn't have enough shares available to lend, you won’t be able to complete the short sale.

Key Takeaways

Shorting stocks on Robinhood can be a lucrative strategy if you believe a stock’s price will fall. However, the process comes with significant risks, including the potential for unlimited losses and margin calls.

To execute a short sale on Robinhood:

1. Open a margin account with at least $2,000.
2. Confirm stock availability for borrowing.
3. Place a sell order without owning the shares.
4. Monitor your position closely, considering market changes and potential short squeezes.
5. Cover your short by buying back the shares when the price has dropped, ideally profiting from the difference.

Understanding both the risks and rewards of short selling is crucial to making informed investment decisions on Robinhood.