Definition of Short Sale
A short sale occurs when you sell stocks that you have borrowed with the hope that the price will go down and you can repurchase the borrowed shares for less money. Your profit is equal to the decrease in the price multiplied by the number of shares you short sold.
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Where Borrowed Stock Comes From
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When you make a short sale of stock, you must borrow the stock from someone else. Usually it comes from your brokerage's inventory of stock but it also might come from another client's margin account or another financial institution.
Completing the Trade
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When the investor believes the price of the stock is as low as it will go (after selling the borrowed shares), she covers her position by repurchasing the shares from the original owner.
Dividends
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If the stock that you have sold pays a dividend before you repurchase the borrowed stock, you must pay the dividend as well.
Limits
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Most short sales require you to maintain an account balance of at least 150 percent of the price of the stock that you short sold to make sure you have the money to repurchase the stock.
Risks
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When you buy a stock, the most you can lose is the amount you pay for the stock, because the price of the stock cannot fall below zero. However, with a short sale your losses are technically unlimited because there is no cap on how high a stock price can rise.
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