what is a short sale 
a short sale is the sale of an asset such as a bond or stock that the seller does not own it is generally a transaction in which an investor borrows a security from a broker and then sells it in anticipation of a price decline the seller is then required to return an equal number of shares at some point in the future the assumption behind a short sale is that if the price declines the seller can buy the security back at the lower price and return it to the broker in contrast a seller in a long position owns the security or stock hispanollstic getty imagesunderstanding short salesa short sale is a transaction in which the seller does not actually own the stock that is being sold instead it is borrowed from the broker dealer through which they are placing the sell order the seller must then buy back the stock at some point in the future short sales are margin transactions and their equity reserve requirements are more stringent than for purchases brokers borrow the shares for short sale transactions from custody banks and fund management companies which lend them as a revenue stream firms that provide for securities lending include charles schwab and fidelity investments 12the main advantage of a short sale is that it allows traders to profit from a drop in price short sellers aim to sell shares while the price is high and then buy them later after the price has dropped short sales are considered risky because if the stock price rises instead of declines there is theoretically no limit to the investor s possible loss as a result most experienced short sellers will use a stop loss order so that if the stock price begins to rise the short sale will be automatically covered with only a small loss be aware however that the stop loss triggers a market order with no guaranteed price this can be a risky strategy for volatile or illiquid stocks short sellers can buy the borrowed shares and return them to the broker any time before they re due returning the shares shields the short seller from any further price increases or decreases the stock may experience short sale margin requirementsshort sales allow for leveraged profits because these trades are always placed on margin which means that the full amount of the trade does not have to be paid for therefore the entire gain realized from a short sale can be much larger than the available equity in an investor s account would otherwise permit the margin rule requirements for short sales dictate that 150 of the value of the shares shorted needs to be initially held in the account therefore if the value of the shares shorted is 25 000 the initial margin requirement would be 37 500 this prevents the proceeds from the sale from being used to purchase other shares before the borrowed shares are returned 3however since this includes the 25 000 from the short sale the investor is only putting up 50 or 12 500 4short sales are typically executed by investors who think the price of the stock being sold will decrease in the short term such as a few months short sale risksshort selling has many risks that make it unsuitable for a novice investor short selling limits maximum gains while potentially exposing the investor to unlimited losses a stock can only fall to zero resulting in a 100 loss for a long investor but there is no limit to how high a stock can theoretically go a short seller who has not covered their position with a stop loss buyback order can suffer tremendous losses if the stock price rises instead of falls for example consider a company that becomes embroiled in a scandal when its stock is trading at 70 per share an investor sees an opportunity to make a quick profit and sells the stock short at 65 but then the company is able to quickly exonerate itself from the accusations by coming up with tangible proof to the contrary the stock price quickly rises to 80 a share leaving the investor with a loss of 15 per share for the moment if the stock continues to rise so do the investor s losses short selling also involves significant expenses these include the costs of another major obstacle that short sellers must overcome is market efficiency markets have historically moved in an upward trend over time which works against profiting from broad market declines in any long term sense furthermore the overall efficiency of the markets often builds the effect of any kind of bad news about a company into its current price for instance if a company is expected to have a bad earnings report in most cases the price will have already dropped by the time earnings are announced therefore to make a profit short sellers must anticipate a drop in a stock s price before the market analyzes its cause short sellers also need to consider the risk of short squeezes and buy ins finally regulatory risks arise with bans on short sales in a specific sector or in the broad market to avoid panic and selling pressures near perfect timing is required to make short selling work unlike the buy and hold method that allows time for an investment to work itself out only experienced traders should sell short as it requires discipline to cut a losing short position rather than adding to it and hoping it will work out to be successful short sellers must find companies that are fundamentally misunderstood by the market e g enron and worldcom for example a company that is not disclosing its current financial condition can be an ideal target for a short seller while short sales can be profitable under the right circumstances they should be approached carefully by experienced investors who have done their homework on the company they are shorting both fundamental and technical analysis can be useful tools in determining when it is appropriate to sell short criticism of short salesbecause it can damage a company s stock price short sales have many critics including companies that have been shorted legendary investor warren buffett welcomes short sellers the more shorts the better because they have to buy the stock later on he is reported to have said according to him short sellers are necessary correctives who sniff out wrongdoing or problematic companies in the market 5before attempting to sell short enroll in one of the best investing courses you can find to learn more about the risks rewards and trading techniques of this investment strategy example of a short salesuppose an investor borrows 1 000 shares at 25 each or 25 000 let s say the shares fall to 20 and the investor closes the position to close the position the investor needs to purchase 1 000 shares at 20 each or 20 000 the investor captures the difference between the amount they receive from the short sale and the amount they paid to close the position or 5 000 short sale in real estatein real estate a short sale is the sale of real estate in which the net proceeds are less than the mortgage owed or the total amount of lien debts that secure the property in a short sale the sale is executed when the mortgagee or lienholder accepts an amount less than what is owed and when the sale is an arm s length transaction although not the most favorable transaction for buyers and lenders it is preferred over foreclosure 