Quick definition A short sale is selling shares you do not own, borrowing them from a broker or lender. You return the borrowed shares later, hopefully after buying them back at a lower price and pocketing the difference. What it is To short a stock, you instruct your broker to borrow shares and sell them. You receive cash from the sale. Later, you buy the shares back (hopefully at a lower price) and return them to the lender. If the price falls from 100 to 80, you make 20 dollars per share profit. Short selling requires borrowing shares, which incurs a borrowing fee. The lender can also recall the shares at any time, forcing you to buy them back. Why it matters Short selling is essential to market efficiency. Short sellers bet against overvalued companies and push prices toward fair value. Without short selling, prices might stay inflated longer. Short selling is also controversial. A short squeeze (when shares are hard to borrow and short sellers are forced to buy, causing prices to spike) can create artificial gains. Some regulations limit short selling. Short sale versus regular sale A regular sale is selling shares you own. A short sale is selling shares you do not own (borrowed shares). The short seller must eventually return the shares. Short sale regulations Regulation SHO restricts short sales. In the US, short sales can only occur on an uptick (the price must have moved higher than the previous trade price). This rule, called the uptick rule, prevents short sellers from piling on during crashes. Practical example You believe Apple is overvalued at 150 dollars. You short 1,000 shares, borrowing them from your broker. You immediately sell the shares for 150,000 dollars. If the price falls to 140 dollars, you buy 1,000 shares for 140,000 dollars and return them to your lender. You keep the 10,000 dollar profit (minus borrowing fees and transaction costs). If the price instead rises to 160 dollars, you are forced to buy at 160,000 dollars and return the borrowed shares. You lose 10,000 dollars. Short squeeze If a stock is heavily shorted and shares become hard to borrow, short sellers are forced to buy back (cover) their positions, pushing the price higher. This can create a short squeeze where prices spike higher. See also - Uptick Rule - Short Squeeze - Margin - Naked Short Sale
