Idiot's guide to short selling

[xyzedarteerf]

I'm sure I'm not alone in asking what is short selling? I have been reading a lot of the threads regarding this topic but people in the threads seem to have different explanations to what short selling is.

Please don't make this thread a debate. Just a plain and simple explanation for us newbie in trading thank you.

 

[Viginti]

In real simple terms, selling a share you dont own in the hope you will be able to buy it at a cheaper price to close out the transaction.

For example, sell share at $20. You dont own the share so you technically now owe your broker one share. Share price falls to $15. You buy one share to pay your broker back. You pocket the $5. Obviously there is brokerage, but for simplicity I have ignored.

 

[Trembling Hand]

Some people think Why would you lend your stock to someone who is then going to sell it into the market and POSSIBLEY depress the price.

The lender gets interest on that stock that they have lent out to the Shorts. Like anyone who provides a loan of some asset. If they are a long term holder that's extra income. The other thing is MOST shorting actually supports the price. Because when you are short you have to then go into the market to buy that stock back thus creating a buy transaction.

 

[cuttlefish]

This is my understanding of things:

Naked short selling: This is literally selling a share that you don't have and that doesn't exist, but plan to buy it back later at a lower price in order to deliver it to the purchaser. The ASX allows naked short selling up to a maximum threshold on selected stocks. It is fully transparent in that it is indicated in the trade code that it is a short, and it is also possible to see a full list of the volume of naked short positions on the ASX site. (http://www.asx.com.au/data/shortsell.txt).

Covered short selling: This is where stock is 'borrowed' from another shareholder via a legal arrangement with a commitment to 'return' the stock to that shareholder at a later date. The 'borrowed' stock is then sold on the market, with the seller intending to repurchase it on market more cheaply in the future to 'return' it to the 'lender'. (I use quotes for 'borrow', 'lend', 'return' because it can be argued that these terms are being misused in this situation). This process is not as transparent as naked short selling because there is no clear disclosure process for stock borrow/lending however if you keep an eye on substantial shareholder notices for a stock you can often find the trail left by short selling (but this would only apply if the lender is a substantial shareholder - which more often than not is the case because the lenders are typically institutions as I understand it).


Going Short/Short position/Short Trade: This refers to any situation whereby a trader is making an investment that is going to benefit from the underlying instrument going down in price. (e.g. buying a put option, selling a call option, selling a futures contract, short selling a stock etc.).