Short Selling

• In a short sell, the seller does not actually own the shares of stock that he sells. Instead, he uses a broker, that borrows the shares from her other clients. In essence, it sort of creates extra shares of a stock. When the seller speculates that the share prices will drop, he borrows and sells the shares at the current market price. After they drop, he buys them back and realizes the gain. For example, selling 100 shares at $72 and buying them back at $40 equals a gain of $3,200 minus any fees to the broker.
  
  

Risks

• While there is a large, but limited, gain potential with shorting, there is also an unlimited loss potential. The investor covers any dividends that the issuing company pays while he is using the stock. Should the share price increase, he is responsible not only for the original cost, but the difference between that and the higher market price. He still owes any applicable fees to the broker also. For example, the investor borrows 100 shares at $15 and subsequently the price rises to $45. His loss in the stock is $3,000, plus any applicable broker fees.
  
  

The Process

• To short sell, an investor contacts his broker and tells her which stock he wants to borrow and sell. Generally, a broker will require that the investor have a certain percentage of the total amount he is borrowing within his account prior to beginning the process. After the sale, the investor usually has three days to complete the buy back.
  
  

Ban on Shorting

• Short selling was a prominent source of investing due to rising market volatility in 2008. This activity further exacerbates that volatility because of the constant selling and purchasing of shares. To restrict this, the U.S. Securities and Exchange Commission placed a three week ban on short sells, and rather hesitantly. To reduce downward pressure short sellers place on certain stocks, the SEC imposed a new restriction in 2010. This allows long sellers to first sell their shares in a stock prior to short sellers.