Short Selling Defined

The sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is motivated by the belief that a security’s price will decline, enabling it to be bought back at a lower price to make a profit. Short selling may be prompted by speculation, or by the desire to hedge the downside risk of a long position in the same security or a related one. Since the risk of loss on a short sale is theoreticallyTrading-Places infinite, short selling should only be used by experienced traders who are familiar with its risks. Consider the following short-selling example. A trader believes that stock SS which is trading at $50 will decline in price, and therefore borrows 100 shares and sells them. The trader is now “short” 100 shares of SS since he has sold something that he did not own in the first place. The short sale was only made possible by borrowing the shares, which the owner may demand back at some point. A week later, SS reports dismal financial results for the quarter, and the stock falls to $45. The trader decides to close the short position, and buys 100 shares of SS at $45 on the open market to replace the borrowed shares. The trader’s profit on the short sale – excluding commissions and interest on the margin account – is therefore $500...READ

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