What is the difference between shorting and naked shorting?

By Ryan C. Fuhrmann AAA
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.  

 

 

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