A:

Short selling involves borrowing shares of a company’s stock and selling it with the hope it can be bought back at a later date at a lower value. This strategy is a way to profit from the fall of a stock price. It is generally not looked on favorably because of fears it can help send stocks on a downward spiral. Naked short selling on the other hand involves betting that the stock will go down in price without actually borrowing the stock or finding out if there is available stock to borrow in order to short it. Without an inventory of stocks to borrow, naked shorting can leave a stock open to market manipulation.

In the U.S., short selling is legal as long as there is an inventory of stocks to borrow. Naked shorting is illegal but due to various loopholes in the rules and discrepancies between paper and electronic trading systems, cases of naked shorting sometimes happen.

Short selling is praised and criticized by many governments, economists and financial professionals. One school of thought argues that short selling helps any overvalued security to achieve its real market value and placing restrictions on it causes the asset to have an unreal value. Some oppose to this theory and argue that short selling only brings more volatility to the market place and that investors and traders should not be profiting from a company or asset's loss.

RELATED FAQS
  1. 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 >>
  2. Why is short selling illegal in some countries but legal in the U.S.?

    Discover why many countries around the world banned the practice of short selling financial stocks and why the United States ... Read Answer >>
  3. 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 >>
  4. When short selling, how long should you hold on to a short?

    Explore the reasons for short selling and the various factors that influence how long an investor may wish to maintain a ... Read Answer >>
  5. 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 >>
Related Articles
  1. 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.
  2. Trading

    Naked Call Writing: A Risky Options Strategy

    Learn about this aggressive trading strategy to generate income as part of a diversified portfolio.
  3. Trading

    Why is Short Selling Legal? A Brief History

    Short selling -- selling borrowed stock in hopes the price goes down --used to be unregulated.
  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. 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.
  6. 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.
  7. Trading

    Short Interest: What It Tells Us

    Whether you agree with the overall sentiment or not, short interest is a data point worth adding to you overall analysis of a stock.
RELATED TERMS
  1. Naked Shorting

    The illegal practice of short selling shares that have not been ...
  2. Short Selling

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

    Buying back borrowed securities in order to close an open short ...
  4. Naked Option

    A trading position where the seller of an option contract does ...
  5. Naked Position

    A securities position that is not hedged from market risk. Both ...
  6. Weak Shorts

    Traders or investors who hold a short position in a stock or ...
Hot Definitions
  1. Collateral Value

    The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...
  2. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  3. Current Account

    The difference between a nation’s savings and its investment. The current account is defined as the sum of goods and services ...
  4. Liability

    Liabilities are defined as a company's legal debts or obligations that arise during the course of business operations.
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Covered Call

    An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset ...
Trading Center