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

    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.
  2. 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.
  3. 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.
  4. Trading

    The Short Squeeze Method

    The short squeezed strategy can be risky - but also very rewarding - for those who master it.
  5. Trading

    Why is Short Selling Legal? A Brief History

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

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
Frequently Asked Questions
  1. How did the ABX index behave during the 2008 subprime mortgage crisis?

    Read about the disastrous performance of the various ABX indexes in the subprime mortgage crisis of 2008 during the middle ...
  2. How did moral hazard contribute to the 2008 financial crisis?

    Learn about moral hazard, how it can affect outcomes and how it contributed to the conditions that led to the 2008 financial ...
  3. Which mutual funds made money in 2008?

    Read about the only mutual fund that turned a profit in 2008. Learn about risk-averse investment strategies and the financial ...
  4. Were Collateralized Debt Obligations (CDO) Responsible for the 2008 Financial Crisis?

    Collateralized debt obligations are exotic financial instruments that can be difficult to understand, Learn the role they ...
Trading Center