Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Short Covering

What it is:

Short covering refers to the practice of purchasing securities to cover an open short position. To close out a position, a trader purchases the same number and type of shares that he sold short.

How it works (Example):

Traders sell a stock short because they believe the stock's price will fall. But if the stock's price goes up, the trader may choose to reduce or eliminate her exposure to a short position.  This process is called short covering.

For example, a trader shorts 1,000 shares of XYZ stock at $20 per share, believing the share price will fall. Instead, the price rises to $25 per share.  The trader has substantial loss exposure, so she purchases 1,000 XYZ shares at $25 per share to cover her short position.

Why it Matters:

Short covering allows traders to protect themselves against potential losses if the market moves against them.  Short covering puts the trader in a market neutral position and is a common practice among hedge traders.

To learn more about short selling, click here to read Shorting Stocks: How to Find the Perfect Candidate for Profits.

Related Terms View All
  • European Option
    Suppose an investor buys a European call option on March 1st that expires on the third...
  • U.S. House Financial Services Committee
    The U.S. House Financial Services Committee also has jurisdiction over the country's...
  • Official Strike
    For example, let's say that the unionized workers of Company XYZ feel that they are...
  • Taxpayer Bill of Rights
    In 1988, Congress passed the first Taxpayer Bill of Rights. Congress then updated it in...
  • Lease to Own
    For example, let's say John Doe's son, Jake, wants to learn to play the flute. Flutes...