PostHeaderIcon Basics of Short Selling

Short SellingShort selling is a common type of investing technique usually used in buying stocks. Short selling is the practice of selling a stock that the seller actually doesn’t own. It can be a sale of a security that the seller does not own but has issued the promise to deliver. It is the opposite in buying "long" which refers to buying stock and then holding it, with hopes of profiting from an increase in its future price.

Short Selling Features

In a simple scenario a short sale involves selling a stock that a broker has lent to the seller. The stock may come from different sources. They can be from a brokerage’s own inventory of stocks, from those of another brokerage firm or from one of the brokerage firm’s customers.

Realizing Profits

When the stocks are sold, the proceeds go to the account of the seller. But after that, the seller may have to close the short sale by buying the same number of shares that was sold to cover for the ones that were borrowed. If the price of the stock shares drops upon buying them, the short seller buys them at a lower price for the same number of shares and makes a profit from the difference. But if the price of the stock rises, the short seller may need to by the shares to cover at a higher price, thereby losing money.

Reasons For Short Selling

There are various reasons why some investors practice short selling of stocks. The main reason would be to speculate that the future price of a certain stock would drop. Another reason why some short sell is to hedge their other long term investments to protect them from negative events.

Short Selling Restrictions

Short selling usually takes advantage of a perceived declining market. In fact, short selling has been identified as a contributing factor to an undesirable market volatility due to sharp price declines brought about by the mortgage and credit crisis in late 2008. This led the Securities and Exchange Commission to disallow naked short selling for a month for more than 750 financial companies listed on the exchange.


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