Short Selling
A "Short" Overview
Securities Lending, Hard-to-Borrows and Stock Locate Fees all require the process of short selling to take place in order to be in existence, but what exactly is short selling? Novice investors continually show confusion about the matter, but it is a fairly simple concept to grasp. As buying or going long on a security allows you to profit on the upside, shorting or going short a stock allows you to profit on the downside.
The profit/loss diagram is exactly the same too. If you short a stock and it drops 5%, you have made 5% on the capital you shorted it with. The only difference is the delivery to you and what goes on behind the scenes. When you short a stock a broker must borrow those shares from someone that is currently holding them long.
Unlike buying, where money comes out of your account, if you short 100 shares of IBM trading at $150 you actually take in $15,000 into your account. The reason you take in this money is because by shorting the shares you are temporarily borrowing them, similar to a loan. By shorting you are promising to payback the shares you borrow at a later date. Your hope is that the shares decline in value so that you pay them back with shares worth less than you borrowed them for.
So, if you took in $15,000 worth of IBM stock and the price goes down $10, you then only have to pay back the long holder of the stock 100 shares times $140 per share or $14,000. You get to pocket the $1,000 difference as profit. Like any investments there are some innate risks in short selling, short squeezes being one of the most common.
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