What is short selling?


Quick Answer

Short selling is a method of security trading that investors use to make a profit when a security's price falls, explains Investopedia. To short sell securities, investors borrow securities, sell them, and then buy them back to return them to the lender, hopefully at a lower price.

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Full Answer

Generally, investors can hold a short for as long as they wish, explains Investopedia. However, lenders and brokerages may demand borrowed securities back at any time. Additionally, stockbrokers charge interest on the margin accounts required to short sell securities, which may negate any profits made from lower security prices. Investors also owe the lender any dividends paid on borrowed stock, and if a stock splits, the investor owes the lender double the number of shares.

Many experts consider short selling very risky, as average securities rise in price every three out of four years, explains Kiplinger. Even poorly performing markets generally rise eventually. On the other hand, short selling adds liquidity to financial markets and helps prevent over-inflated prices, states Investopedia. Short selling is used unethically by some traders to manipulate stock prices.

Some investors also short sell securities without borrowing them at all, in what is known as naked short selling, reports CNN. Some jurisdictions ban this practice, as it allows further manipulation of financial markets.

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