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When applying for a form of credit such as a personal loan or credit card, applicants likely have their credit score top of mind. As they review their different credit scores, they may wonder: What’s the difference between a FICO score and a credit score?

Put simply, a FICO score is simply a type of credit score that uses the FICO credit scoring model. A credit score is essentially a generic term, whereas a FICO score is a credit score created by a specific brand.

What Is a FICO Score?

A FICO Score is a type of credit score that’s created by the Fair Isaac Corporation (FICO). It’s a very popular form of credit score, and many companies rely on it when determining the creditworthiness of applicants.

Not all lenders use FICO score models though, as some use their own credit scoring models or rely on a score made by one of FICO’s competitors.

Is a FICO Score the Same as a Credit Score?

The main difference between FICO scores and credit scores is that FICO credit scores are only offered by the brand FICO, as this particular score relies on FICO’s specific credit scoring model. A credit score, on the other hand, is a generic term referring to scores created by any model, as all credit scores are backed by a credit scoring model.

Essentially, what many credit scores do is predict how likely someone is to make their debt payments on time. FICO scores specifically predict how likely it is that someone will fall 90 days behind on a payment within the next 24 months. This credit limit is determined based on a complex algorithm that uses information from credit reports made for each consumer by the three major credit bureaus (Equifax, Experian, and TransUnion). FICO occasionally updates how it determines its scores and releases new versions of the FICO Score.

The higher someone’s credit score is — no matter where the credit score comes from — the higher credit limit and the less likely they are to miss a debt payment. The more reliable a borrower appears to be based on their credit score, the better terms a lender is likely to offer them. A lower interest rate, for instance, can lead to savings, as demonstrated by this personal loan calculator.

FICO Score vs Credit Score: Which Is Better?

A FICO score is not inherently better or worse than a credit score. The term credit score applies to the general concept of the score that comes from a credit scoring model. The FICO Score is simply a brand-name version of a credit score.

All lenders get to decide if they want to use their own internal credit scoring models or one from a brand like VantageScore or a FICO credit score. However, none of the different types of credit scores is necessarily better than the other.

FICO vs VantageScore

As briefly noted before, there are other brands that offer other credit scores to lenders. VantageScore is one of FICO’s main competitors. Like a FICO credit score, VantageScore relies on information from the three major credit bureaus’ credit reports to determine scores.

Both FICO Score and VantageScore give higher credit scores to more creditworthy individuals and their credit rating scales range from 300 to 850. Where these two scoring models differ is in how they determine their scores.

With different FICO scores, there are five categories of information that make up the overall credit score, and each category is given a different weight:

•   Payment history: 35%

•   Credit utilization rate: 30%

•   Length of credit history: 15%

•   Mix of your credit accounts: 10%

•   New credit accounts: 10%

VantageScore, on the other hand, uses six different categories, but doesn’t assign specific weights using a percentage. Instead, VantageScore places a different level of influence on each category:

•   Payment history: Extremely influential

•   Credit utilization: Highly influential

•   Length of credit history and mix of credit accounts: Highly influential

•   Amounts owed: Moderately influential

•   Recent credit behavior: Less influential

•   Available credit: Less influential

Why Is a FICO Score Important and What Is It Used for?

FICO credit scores play an important role when it comes to borrowing money. This is because an applicant’s FICO score indicates how likely they are to make their debt payments on time. The more likely someone is to repay their loan, the less of a risk they pose to lenders.

Because of this, a high credit score is helpful if you want to get approved for a personal loan or a credit card, among other types of loans. Lenders use FICO scores and other types of credit scores to determine how much money to lend someone, how long they have to pay their loan back, and how high their interest rate should be.

What Affects Your FICO Score?

A handful of different factors affect a consumer’s FICO score. The most important among those is payment history. Someone who consistently makes on-time payments will have a higher score, which is why prompt payment is critical to accessing top credit cards and leveraging common uses for personal loans down the road.

The next most important factor affecting a FICO score is how much of available credit someone is using. Using up a lot of one’s available credit indicates to top lenders that a borrower is overextended and may not be able to afford new loan payments.

Someone’s length of credit history also plays a role, and having a longer credit history can help give someone’s FICO score a boost. Having a good credit mix made up of different types of credit — like installment loans, retail accounts, auto loans, and mortgage loans — is also taken into consideration, as is how recently someone opened new credit.

How Do I Get a FICO Score?

Getting a FICO score is easy. Consumers typically can access their FICO score through lenders, credit card issuers, credit bureaus, and select financial institutions.

Because the FICO Score is such a popular credit report, some consumers may want to know what their FICO Score is before they apply for a new form of credit, such as a type of personal loan. That way, they can get an idea of whether they may qualify and under what terms.

The Takeaway

The FICO score is simply a type of credit score that utilizes a credit scoring model from the brand FICO. Many lenders choose to use the FICO score when deciding which applicants to lend money to and what terms to offer them — including how much interest to charge them. That being said, some lenders choose to use use industry specific scores, competitor models, or their own internal models to determine who they want to lend money to.

Before applying for a personal loan, it’s important to make sure you know where your credit score stands. For those who aren’t sure what type of interest rates they may qualify for, SoFi is here to help. With SoFi, you can find what interest rates you qualify for within 60 seconds, and with no commitment required. From there, you can complete your application and receive funds as soon as the same day.

About the author

Jacqueline DeMarco

Jacqueline DeMarco is a freelance writer who specializes in financial topics. Her first job out of college was in the financial industry, and it was there she gained a passion for helping others understand tricky financial topics. Read full bio.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Shorting a stock, also known as short selling, is one way to potentially profit from a stock’s price decline.

When investors think a stock’s price will fall, they can sell borrowed shares, repurchase them at a lower price, and potentially pocket the difference as profit. This strategy is popular among experienced and risk-tolerant investors who conduct thorough market analysis before taking a short position.

For new investors, the idea of making trades that can be profitable even when the price falls may sound strange. After all, the traditional way to profit in financial markets is a buy-and-hold strategy: purchasing a security, holding it, and selling it later for a higher price.

However, by understanding how short selling works, investors can utilize new strategies to potentially bolster their financial portfolios.

What Is Shorting a Stock?

A trader shorts a stock when they think its price will fall. Shorting involves borrowing the stock from a brokerage, selling it, and then buying it when the price is lower than when they sold. The trader then returns the shares to the brokerage and may realize a profit, provided the shares sold for more than they were bought back for.

Shorting a stock allows investors to take a position that anticipates a stock’s future share price will be lower than its current price. It’s the opposite of going “long” on a stock, where an investor buys shares with the expectation that the stock price will increase.

Short selling can be risky because if the stock price goes up instead of down, the investor will have to buy the shares at a higher price and may lose money.

Recommended: Short Position vs Long Position, Explained

Why Short a Stock?

There are several motivations for shorting a stock. In general, traders might short a stock when they believe that the security’s price will fall in the future. This might be due to several factors, such as an overall bearish outlook on the market, or specific concerns about a company’s financial health or prospects.

Some traders might also short a stock to hedge their portfolios by reducing exposure to potential losses in long positions. For example, if a trader is long a stock that they think will fall in value, they might short a similar stock to offset potential losses.

Shorting a stock can be a risky proposition regardless of strategy. If the stock price does not fall as expected, the trader will be forced to cover their position at a loss. As such, traders must be cautious when considering whether or not to short a stock.

How to Short a Stock

There are several steps involved in shorting a stock.

1. Set Up a Margin Account

First, you’ll need to set up a margin account with your brokerage. Margin accounts allow traders to borrow shares from a brokerage to sell them. They also enable traders to borrow the funds needed to take on larger positions in a short than they could with their own account balance.

2. Identify a Stock to Short

With a margin trading account funded and ready to go, investors typically target stocks they believe are overvalued or have weak fundamentals. These tend to be more likely to experience price declines. Some common indicators are declining earnings, negative media attention, or a downward trend in the stock’s price.

3. Place a Short Sell Order

After identifying a stock to short, it’s on to the execution phase. To do this, a trader places a short sell order through their brokerage account. The order instructs the broker to borrow shares from an investor or institution and sell them on the open market at the current price, on your behalf.

Traders can choose between a market order (sells the shares at the best available price) or a limit order (specifies the price at which you’re willing to sell).

4. Monitor Your Position

Short sales carry higher risks than other trades, which makes it vital to monitor the position closely and adjust their strategy as market conditions change. Potential gains and losses are amplified when margin is involved. Gains are limited by the difference between the strike and short sale price, and your risk of loss is unlimited.

Stop-loss orders and other stock orders can help manage risk by automatically closing a position if the stock moves against your position for a certain amount of time.

5. Close the Short Position

To close a short position, the trader must repurchase the same number of shares they borrowed. Ideally, they would buy the shares at a lower price than the original sale price. This is known as “buy to cover,” and it allows the trader to return the shares to the brokerage. The trader then realizes any profit or losses based on the price difference.

In rare cases, the lender may request that the trader return the shares they borrowed, but it’s far more likely for the trader to close their position at that point since the short would likely be losing money in this scenario. A short seller can hang onto their short position for as long as they can pay the required interest fees for borrowing stock and maintaining the margin amounts required by the brokerage firm.

What Are The Risks and Rewards of Short Selling?

As noted, there can be some significant risks associated with short selling. But there can be potential rewards, too.

Risks of Short Selling

Selling a stock short involves significant risk — far surpassing the risk of “going long” on an investment. When holding a stock, there’s a limit to how low a stock can go, and investors can only lose as much as their initial investment.

If someone buys 10 shares of XYZ company at $10 per share, for example, and the share price goes to zero, they will lose $100. The price can’t go lower than zero, so someone can never lose more than what they had first invested.

However, when someone shorts a stock, they risk potential losses that are unlimited, as there is the potential for a stock’s price to rise indefinitely. If the price keeps going up, they will keep losing money.

Additionally, there are significant costs associated with shorting a stock. For one, the margin interest in a required margin account can add up over time if an investor keeps the position open for a while. Brokerage firms will charge interest on the borrowed shares, ranging from a few basis points to more than 100%, depending on how difficult the shares are to borrow. These costs can make shorting a stock prohibitively expensive.

Potential Benefits of Short Selling

While risky, shorting a stock could be profitable. Short selling may result in substantial gains during rapid price declines, though it also carries risk.

When investing during a recession, for example, sudden drops in the share prices of many stocks across many different industries can occur. While this might cause many investors’ portfolios to decline, others may be profiting because of their short positions.

Investors might choose to short a stock to hedge against their long positions. The term “hedge” is used to refer to an investment that protects against losses in another asset. So, in this case, an investor may put on a short position to hedge or offset a potential loss in a long position.

Short Selling Techniques and Best Practices

There are numerous short-selling strategies that investors might employ, and several of them are relatively straightforward, but require careful risk assessment.

For example, one technique that investors can use is to short sell a stock that is in a longer-term downtrend, but that has seen a short-term bounceback in value — it may continue that downtrend after a short time. Additionally, investors might enter a position (with proper risk management in place) when price trends are ambiguous. Investors can even try short selling while a stock is seeing an active decline. If that decline continues, investors could potentially capitalize on it, though other short-sellers could catch on, too.

What Happens in a Short Squeeze?

A short squeeze refers to the rapid flight of short sellers from a stock in order to limit losses — a situation that leads in a dramatic surge in the stock’s price.

Here’s how they typically occur: a sudden increase in the stock price causes investors to scramble to close their short positions by purchasing shares. This results in further gains in the stock, which in turn causes massive “covering” by other short sellers, bringing about a “squeeze.”

Famous cases include Volkswagen in 2008, which involved unusual circumstances related to Porsche’s increased stake in the German automaker, causing a short squeeze that briefly made Volkswagen the world’s most valuable stock by market cap.

In January 2021, the gains in GameStop (GME), a brick-and-mortar video-game retailer, were due to a massive short squeeze after retail investors piled into the stock, which hedge funds heavily shorted. Shares of movie-theater operator AMC Entertainment Holdings (AMC) and retailer Bed Bath & Beyond underwent similar experiences.

Is Shorting a Stock Wrong?

Short selling often raises ethical and moral concerns, particularly because it profits from the decline of a company’s share price. From a regulatory standpoint, short selling is legal and is recognized as a legitimate trading strategy. The practice can also aid with price discovery, which is how the market determines the fair value of a financial asset.

Concerns arise when short selling is associated with market manipulation, or when it is used to target companies for reasons outside of share valuation.

Legal and Ethical Considerations

Some investors have attempted to manipulate stock prices by spreading false bullish. Such tactics are considered market manipulation, and are illegal. Anyone caught attempting to manipulate markets might be subject to regulatory punishment by the Securities and Exchange Commission (SEC).

The ethical considerations about short selling focus on its potential to harm markets and the companies that list shares on them. Some critics argue that it can be used to spread false information about a company’s performance or long-term sustainability, especially during a short squeeze. Proponents suggest that short selling helps identify overvalued stocks, which can help make markets more efficient.

Alternatives to Shorting a Stock

Investors that want to capitalize on potential stock price declines, but without directly shorting them, can consider alternative strategies.

The first alternative to consider are put options. A put option is an options contract that gives the buyer the right to sell shares of an underlying asset at its strike price up until the option’s expiration date. The put option buyer pays a premium for the contract.

For example, imagine that an investor wants to short a stock whose shares are currently selling for $10. The investor believes the company is overvalued and the stock will soon head to $8 or lower.

The investor would buy a put option for the stock with a strike price of $10 and an expiration date of three months in the future. The investor pays a $1 premium for the put. If the stock falls under $10 during that time, the investor could exercise the contract to make money on the put option.

Suppose the stock falls below $8, as the put option investor forecasted. They could sell it for an increased premium to someone else. If an investor were to exercise the option, they’d profit from being able to sell shares for $10 that are worth $8, pocketing the $2 difference, minus the $1 premium, leaving them with $1. Since each option contract is usually worth 100 shares, the total profit would be $100.

Inverse ETFs

Inverse ETFs, or short ETFs, are another way to make a bearish trade. These investment vehicles use futures contracts to provide returns that are opposite the performance of an underlying index. Inverse ETFs assume either the broader markets, a particular asset class, or a market sector will go down in the short term.

For example: investors who believe a stock price will drop can buy a futures contract at a higher price, and if the share price does go down, the trader can buy the cheaper shares and then sell them at the higher price specified in the futures contract, thus realizing a profit.

An inverse ETF aims to provide opposite returns of a benchmark index uding derivatives such as futures or swaps, rather than directly shorting stocks. The biggest such ETFs are designed to provide the inverse returns of indexes like the Russell 2000 or the S&P 500. For example, if the S&P 500 goes down 1% on a given day, then a corresponding inverse ETF could be designed to go up 1% that day.

The Takeaway

Shorting a stock occurs when investors bet that the price of a specific stock or ETF will fall. Sophisticated investors with a bearish view of the market will often go short to profit from falling share prices. Short positions also help investors mitigate losses during widespread market downturns or hedge losses from another holding.

While shorting can be a useful investment tool, it’s also very risky. There is no limit to how high a stock can go, meaning there’s also no limit to the losses a short seller can potentially book. Trading on margin can multiply losses as well if the short sale does not go as the trader anticipates. In some cases, using an options trading strategy may accomplish similar results to going short.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

FAQ

What is a margin account and why do I need one for short selling?

A margin account is a type of brokerage account that allows investors to borrow money from their brokers to increase their purchasing power. A margin account is required in order to borrow the shares necessary to take a short position.

How can I manage the risks of short selling?

Thorough research and a robust strategy can help manage some of the risk involved in short selling. Traders may want to consider setting up and using stop-loss orders, which can exit a trader from their position if the stock gains value during a certain period of time. Lastly, it’s crucial to only invest as much as you are willing to lose. This can help right-size the role short selling has in your portfolio.

Can I short sell any stock?

No, there are restrictions on which stocks can be shorted, and they typically depend on the specific brokerage’s rules. For example, investors may not be able to short penny stocks, or short during specific market periods. There are also regulations about shorting that traders need to be aware of as well.

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