Section: 7 Trading on Exchanges

Sub Section: 7 Short Sales

Normally, an investor would first buy a stock and later sell it. With a short sale, the order is reversed. First, you sell and then you buy the shares. In both cases, you begin and end with no shares. A short sale allows investors to profit from a decline in a security's price. An investor borrows a share of stock from a broker and sells it. Later, the short-seller must purchase a share of the same stock in the market in order to replace the share that was borrowed. This is called covering the Short position.

The short-seller anticipates that the stock price will fall, so that shares can be purchased at a lower price than it initially sold for; if so, the short-seller will reap a profit. Short-sellers must not only replace the shares but also pay the lender of the security any dividends paid during the short sale. In practice, the shares loaned out for a short sale are typically provided by the short seller's brokerage firm, which holds a wide variety of securities of its other investors. The owners of the shares need not know that the shares have been lent to the short-seller.