It means you're not giving yourself full credit where it is deserved. You are underestimating the true value or worth of yourself. For example you had an interview for a job, but you didn't get ,although you are very well qualified even for a better job than that one. Your friend knowing this tells you : "Come on, you can apply for a much better job. Don't sell yourself short." It means also being modest about someone's achievement. " He doesn't project himself very well and tends to sell himself short." Another example is that some people sell themselves short in relationships, in the pursuit of love, they get out of their way ,underestimate themselves and bear being verbally, mentally or physically abused. "In her last relationship with that guy who already had a girlfriend, she was seriously selling herself short."

"YOU'RE selling yourself short". :) We sometimes use "short" to mean "not enough": "I'm short of patience", "he's short of cash", and so on. When someone says "I'm short", it could mean either their height, or the fact that they don't have enough money at that moment. You'll know the right meaning from the context. In this example, the person is undervaluing him/herself and should ask for more money (or respect, attention, etc).

It means the same as "You deserve better". So for example: You are dating this person who is not good for you and you think you can't get someone better than that person. Then your friend tells you, "Hey, you're selling yourself short." Then your friend is saying to you the same thing as, "Hey, you deserve better. You're a good person and you can get someone even more amazing because you're an amazing person!"