Basically, short selling of stocks refers the selling of a stock not necessarily owned by the seller. To be more specific, it is the short sale of a security that the seller does not own but promises to deliver anyway. When you short sell a stock, you must have a broker who lends it to you. The stock may come from the brokerage firm’s own inventory, from another brokerage firm, or from one of your brokerage firm’s customers.

Once the shares are successfully sold, the earnings are credited to your account. Eventually, you would have to “close” the short. This is done by buying back the same number of shares and then returning them to your broker who lent you the stocks you sold. If the price of the stock is lower you make a profit because you could buy the stock back at a lower price. Short sellers lose money when the price of the stock rises because they have to buy it back at a higher price.

Brokers are necessary if you plan on short selling stocks. When you use a broker, you will need to set up an account with a brokerage firm either in cash or a margin account. With cash accounts, you will be required to pay for your stock along with the purchase. On the other hand, securing a margin account with the broker allows you to borrow a portion of the funds at the time of your purchase. The security will serve as your collateral.

In essence, the stock you are short selling does not belong to you as you borrowed it before selling it. You must therefore pay any stock lender the dividends or rights declared during the process of the loan. Therefore, you will owe the lender of the stock twice the number of shares if the stock splits during the course of the loan.

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