The practice of shorting a stock involves betting against a stock’s price, and is a powerful tool for sophisticated investors with a bearish view of the market. But it’s also a risky tactic that can be devastating to those who get caught in the wrong position.

To make a short sale, Shorting Stocks Explained must have a margin account with a brokerage firm, which allows them to sell securities they don’t own by first borrowing them (a process known as share lending). If the stock declines in price, an investor can then buy back the shares at a lower price and pocket the difference. To keep the process safe, brokers require short sellers to pay a fee for borrowing shares and pay interest on any dividends paid while the stocks were borrowed.

Shorting Stocks Explained: Risks & Rewards

There are many reasons to short a stock, including believing that the company is overvalued and that its shares will decline in price. However, the risk of a short sale is unlimited, and it’s important to understand how far a stock’s price can go before you must close out the trade by buying back the lent shares.

In the past, some unscrupulous investors have even attempted to manipulate the price of a stock upward by spreading malicious rumors about a company, which is considered market manipulation and illegal. It’s not clear if such tactics are still in use, but the fact that they can be so damaging to others should give any potential short seller serious pause.