Short selling involves purchasing borrowed shares, selling them and, ideally, returning to the lender the shares which experienced a decrease in price. The investor profits by buying high and selling low, as the investor has a bearish outlook on the company's prospects. In accordance with SEC and exchange rules, stock may be sold short only on a plus tick or zero-plus tick. A plus tick is a price higher than the last different price. The rules are designed to prevent short sellers from feeding orders into a declining market to manipulate a stock's price downward. The maximum gain on a short sale is the difference between the price at which the sale is initiated and zero minus any commissions. The maximum loss is potentially unlimited if the price of the stock rises. The mechanics of a short sale are as follows:

  • The investor opens a margin account.
  • Based upon her research and negative outlook for the company, she initiates the short sale of a round lot of the company's shares at the current market price of $15 ($1,500).
  • The client borrows the shares. Margin accounts allow the broker to lend shares. Large, well-known companies are more likely to have stock available to be sold short.
  • The investor sells the shares, depositing the proceeds in an escrow account.
  • The client covers her short position - with the share price down to $5, the client has the broker buy a round lot of shares for $500.00. The client collects $1,500 and clears $1,000.


Hedging and Options Strategies

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

    Why Short Sales Are Not For Sissies

    Short selling has a number of risks that make it highly unsuitable for the novice investor.
  3. 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.
  4. Trading

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
  5. 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.
  6. Trading

    Difference Between Short Selling And Put Options

    Short selling and put options are used to speculate on a potential decline in a security or index or hedge downside risk in a portfolio or stock.
  7. Investing

    Rules and Strategies For Profitable Short Selling

    Short sales work well in bull and bear markets but strict entry and risk management rules are required to overcome the threat of short squeezes.
Frequently Asked Questions
  1. Why is social responsibility important to a business?

    Take social responsibility seriously, and your business could benefit from happier, more productive staff members while helping ...
  2. Which socially responsible retailers appeal most to ethical investors?

    Learn why ethical investors have many options in the retail sector, and discover which retail companies are most popular ...
  3. What are Some Examples of Free Market Economies?

    Learn which of the world's economies best resemble free market economies, marked by free trade, low government involvement, ...
  4. Who Decides When to Print money in India?

    Find out the role of the Reserve Bank of India, or RBI, and the amount of authority given to the government. Learn who is ...
Trading Center