A short is a financial position that allows one to take a position anticipating that the value of the underlying security will decrease. However, there are some mechanics under the hood that give them some interesting properties.

To short a stock, a person will “borrow” the stock from a counterparty, and promise to repay the counterparty the price of a stock at some specified later date. Consider a stock trading at $10. Person A borrows the stock from Person B and sells it on the open market, thereby pocketing $10. If the stock price declines to $8 when the stock position expires, the person then pays Person B $8, pocketing the $2 profit. If the stock price instead rises to $15, the person will have to pay the $15 and eat the $5 loss.

A “short squeeze” occurs when rising prices put pressure on stock sellers. Unlike when one buys a stock (where the most you can lose is the amount of money you put in), your maximum losses from a short are unbounded (if the stock just keeps rising). As a result, if there is a large short position and the price keeps rising, many short sellers will start buying the stock to hedge their losses. This can push the price up even further, causing further buying.

While many corporate executives such as Elon Musk are disdainful of short sellers, shorts can serve an essential role in the financial ecosystem because of the winner’s curse. The winner’s curse is a phenomenon that occurs when trying to price a common value asset such as a stock (a common value asset is an asset with a potentially unknown value but whose value is equal for all participants; it is in contrast to a private value asset whose value is much greater to one individual than to another). If one is bidding on a common value asset, only the people with the highest estimate of the value of the asset will win the bidding. If we assume that no one has inside information, then the winners are those who are most overconfident of the true value, and will likely lose money on the auction. This phenomenon often occurs in sports free agent markets–even if the average of all team’s estimations of a player’s skill is on average correct, the team that ultimately signs the player is the one with the most bullish over-estimate of the player’s skill. Shorting allows traders to express their belief that a security is overpriced, and push the clearing price back to its “true” value.