Explanation of Selling Short Stocks

Short-sellers sell high and then buy low.

Short-sellers of stocks typically sell shares when they believe the value of the stock will drop. They can then buy and deliver the stocks for a lower price.

Short Position

In a typical short sale, the investor borrows the stock from his broker or another lender. The broker then sells the stock and credits the investor. At this point, the investor is "short" and must then reconcile his position by buying the stock from another party at the current price and returning it to the broker. Short-sellers generally don't own stock; they borrow it, sell it and promise to redeliver it.

Uses

Short-sellers look for overvaluation of a particular stock, or general market conditions that will devalue many stocks at once. Investors may also use short sales to hedge their positions in other stocks.

Investor-Lender Relationship

There is no time limit on a short position, but many lenders will charge investors interest for the loan. Typically, a lender has the prerogative to force the investor to cover his short position at any time. Because the lender is the actual owner of the stock, the lender, not the investor, gets any privileges of stock ownership, such as dividends or voting rights.

Short Sale Profit

A short sale lets the seller sell stock when its price is high and buy it at a lower price when the stock drops. The seller keeps the difference between the selling and buying price.

References

• "Securities Regulation, Cases and Materials"; John C. Coffee and Hillary A. Sale; 2009
• Investopedia: Short Selling
• Trading Markets: 10 Things You Must Know Before Shorting a Stock