A:

Short selling is hard enough to get your head around without getting into all the particulars. If you have a basic understanding of short selling, then you probably know that as a short seller, you are required to make up for any benefits a long investor would receive if he or she had actually owned the stock.

When you short a stock, you are borrowing the stock from an investor or broker, then selling those shares on the open market to a second investor. Even though you borrowed and sold the shares to another investor, the transaction between you and the lender is still listed on the books as if the lender is still long on the stock and you are short on the stock (even though that person no longer owns the stock).

Because that original investor who was kind enough to lend you the stock is no longer an actual shareholder with the company, the short seller is required to make up for any benefits the investor would have received had he or she actually still owned the stock.

In other words, if a company pays a dividend to shareholders, the second investor who bought the shares from the short seller would get the dividend check from the company. But because the original investor is no longer a shareholder of record (because the second investor owns those shares now), then the short seller must pay the dividend out of his or her own pocket.

Finally, when the short seller decides to close out the short position, he or she buys shares on the open market (from a third investor) and then gives the shares back to the original investor, who closes out the short position and puts everything back to square one.

For further information on short selling, please see our Short Selling tutorial.

RELATED FAQS
  1. How is it possible to trade on a stock you don't own, as is done in short selling?

    Understand how the process of short selling allows a person to sell a stock he or she doesn't technically own by borrowing ... Read Answer >>
  2. How does one make money short selling?

    Short sellers make money by betting that the stock they sell will drop in price. If the stock drops, the short seller buys ... Read Answer >>
  3. How long can a trader keep a short position?

    Learn whether there are any limitations on how long may an investor hold a short position, and explore the costs associated ... Read Answer >>
  4. How does short selling help the market and investors?

    Find out how short sellers provide a service to the market by acting as a check against overvalued companies and exposing ... Read Answer >>
  5. What is the difference between a short squeeze and short covering?

    Learn about short covering and short squeezes, the difference them and what causes short squeezes. Read Answer >>
  6. What is the difference between a short position and a short sale?

    Learn how short selling and short positioning are different, specifically in regards to the nature of the commodity being ... Read Answer >>
Related Articles
  1. Investing

    Short Selling Risk Can Be Similar To Buying Long

    If more people understood short selling, it would invoke less fear, which could lead to a more balanced market.
  2. Investing

    The Basics Of Short Selling

    Short sellers enable the markets to function smoothly by providing liquidity, and also serve as a restraining influence on investors’ over-exuberance.
  3. Trading

    Short Sales For Market Downturns

    This strategy can help in market downturns, but it's not for inexperienced traders.
  4. Trading

    Short Interest: What It Tells Us

    This figure can be a real eye-opener about the market sentiment surrounding a given stock.
  5. Financial Advisor

    The 5 Most Shorted NYSE Stocks (VALE, CHK)

    Understand what a short sale is and why people would want to initiate a short strategy. Learn about the top five most shorted stocks on the NYSE.
  6. Investing

    Short Interest: What It Tells Us

    A stock’s short interest is the total number of shares that investors have sold short but have yet to close.
  7. Investing

    The Truth About Naked Short Selling

    The media demonizes naked short selling, but in most cases it occurs in a collapse, rather than causing it.
  8. Financial Advisor

    Why You Should Never Short a Stock

    Short selling a stock means you are betting on the stock decreasing in price. Before taking on this investment, you should fully understand the risks
  9. Trading

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
RELATED TERMS
  1. Short Selling

    Short selling is the sale of a security that is not owned by ...
  2. Short Covering

    Buying back borrowed securities in order to close an open short ...
  3. Short Sale

    A market transaction in which an investor sells borrowed securities ...
  4. Short Interest

    The quantity of stock shares that investors have sold short but ...
  5. Weak Shorts

    Traders or investors who hold a short position in a stock or ...
  6. Rebate

    1. In a short-sale transaction, the portion of interest or dividends ...
Hot Definitions
  1. Dumping

    In international trade, the export by a country or company of a product at a price that is lower in the foreign market than ...
  2. Tender Offer

    An offer to purchase some or all of shareholders' shares in a corporation. The price offered is usually at a premium to the ...
  3. Ponzi Scheme

    A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns ...
  4. Dow Jones Industrial Average - DJIA

    The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange ...
  5. Revolving Credit

    A line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is ...
  6. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
Trading Center