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 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 >>
  3. Under what circumstances is short selling advisable?

    Find out when short selling a stock is profitable and what an investor should keep in mind before deciding to pursue a short ... Read Answer >>
  4. How can you lose more money than you invest shorting a stock? If you have no money ...

    The simple answer to this question is that there is no limit to the amount of money you can lose in a short sale. This means ... Read Answer >>
  5. 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 >>
  6. What's the difference between a long and short position in the market?

    Understand long and short positions for stocks and option contracts; combine long and short positions for added leverage ... 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. Trading

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
  3. Trading

    Short Sales For Market Downturns

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

    Why Short Sales Are Not For Sissies

    Short selling has a number of risks that make it highly unsuitable for the novice investor.
  5. Trading

    Short Interest: What It Tells Us

    This figure can be a real eye-opener about the market sentiment surrounding a given stock.
  6. 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.
  7. Trading

    The Difference Between a Long and Short Position

    Stocks are owned in a long position and owed in a short position.
  8. Managing Wealth

    Value Investing & Short Selling Are Like Oil & Water

    To be a good value investor, you need to find and buy bargain stocks but more importantly, you have to stick to the trade until the market recognizes the worth of these securities.
RELATED TERMS
  1. Short Covering

    Buying back borrowed securities in order to close an open short ...
  2. Short Interest

    The quantity of stock shares that investors have sold short but ...
  3. Short Sell Against the Box

    The act of short selling securities that you already own. This ...
  4. Short Squeeze

    A situation in which a heavily shorted stock or commodity moves ...
  5. Cushion Theory

    The theory used when many investors have taken a short position ...
  6. Seller

    1. An individual or entity that exchanges any type of good or ...
Hot Definitions
  1. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  2. Sharpe Ratio

    The Sharpe Ratio is a measure for calculating risk-adjusted return, and this ratio has become the industry standard for such ...
  3. Death Taxes

    Taxes imposed by the federal and/or state government on someone's estate upon their death. These taxes are levied on the ...
  4. Retained Earnings

    Retained earnings is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested ...
  5. Demand Elasticity

    In economics, the demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables. ...
  6. Dark Pool

    A dark pool is a private financial forum or exchange for trading securities.
Trading Center