Short selling is a method of profitting when stock prices fall.
Short selling and selling short are synonymous terms. The opposite transaction would be "buying long".
If you are "short" a stock, it means that you expect the price to go down. Short selling as a strategy has several inherent risks:
- In the long term, stock prices have generally gone up. So taking a short position is either a short-term bet against the market as a whole, or a bet against very specific companies.
- Margin interest. Because the first part of short selling is to sell the stock, it begs the question, "how can you sell what you don't own?". Simple, you borrow it (from your broker in this case). And because you are borrowing the stock and your broker is charging you interest until you return the shares, unless the stock is going down, margin interest charges will start gnawing down your cash. This aspect is another reason that selling short is usually done in a shorter term time frame. The closing transaction is "buy to cover."
- Unlimited liability. When you "buy long", your liability is capped. You can, at most, lose the value of your invesment (IE, if the stock costs $60 you can lose no more than $60). However, if you were to sell short and the stock price rose, there's no limit to the amount of money you could lose (as there is no theoretical upper limit on the stock price).
BEWARE: not all short or selling transactions are in anticipation of a downward move. If you short/sell a put option contract, that is typically a bullish to neutral prediction.
Short selling is controversial and is the subject of SEC proposals to restrict its use. A Wiki with links to the proposals and an opportunity to comment on them appears here.
