Short Selling Defined
Short selling (or shorting) is the act of borrowing a stock from a broker and selling it into the market with the belief that the stock will go down in price. When the stock goes down in price the trader who is short the stock buys it back at the lower price, delivers the stock back to the broker and keeps the difference in price of where they sold it to where they bought it back.
How It Works
EX: XYZ stock is trading at $50 per share.
The trader looks to see whether a broker has XYZ stock that the trader can borrow.
If the stock is available to borrow, the trader borrows the stock and sells it in the market taking in $50 per share.
If the stock goes to $40 the trader only has to spend $40 of the $50 they took in to buy the stock back.
The trader buys the stock back and delivers the stock back to the broker.
The trader keeps the difference between where the trader sold the stock ($50) and where they bought it back ($40) which is a $10 per share gross profit.
Why would a broker allow me to sell stock in their inventory?
The simple answer is because they can make money allowing traders this opportunity. Remember borrowing assumes a small interest rate will be made by the broker on the loaned stock. Short selling enables traders to profit when prices fall and is an essential strategy for long term consistency no matter what the market conditions may be.