Tuesday, December 28, 2010

Short Selling

Short selling is the practice whereby an investor sells stock that they do not own, by borrowing someone else's shares (and paying them interest for that) and then selling them into the market; the investor will need to deliver the shares at a certain point, which they must do so by buying the shares back on the open market. Clearly the investor will make money if the price they initially sell the shares at is higher than the price at which they have to buy them back at later. For example an investor shorts MSFT at $30, and then the price drops to $25, the investor covers the short position by buying back the shares at $25, thereby making a gross profit of $5 per share. Short selling is not permitted in some jurisdictions, however a synthetic short position can be created using stock options or other derivatives e.g. Contracts For Difference (CFDs). Short selling is a useful tool in some circumstances, and there are some major investors and funds that persue strategies centered on finding stocks to short (i.e. those that may face bankruptcy or a deterioration in financial position, or those that are heavily exposed to an asset bubble or market cycle).

Synonyms: Short, Shorting

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