Going short (also called shorting a stock, selling short, or doing a short sale) on a stock is a common technique investors use to profit from a stock price decline. Investors have made big profits during bear markets by going short. A short sale is a bet that a particular stock is going down.
Say that you believe DOA is the right stock to short — you’re pretty sure its price is going to fall. With DOA at $50, you instruct your broker to “go short 100 shares on DOA.” Here’s what happens next:
Your broker borrows 100 shares of DOA stock, either from his own inventory or from another client or broker.
That’s right. The stock can be borrowed from a client, no permission necessary. The broker guarantees the transaction, and the client/stock owner never has to be informed about it because he never loses legal and beneficial right to the stock. You borrow 100 shares, and you’ll return 100 shares when it’s time to complete the transaction.
Your broker then sells the stock and puts the money in your account.
Your account is credited with $5,000 (100 shares × $50) in cash — the money gained from selling the borrowed stock. This cash acts like a loan on which you’re going to have to pay interest.
You buy the stock back and return it to its rightful owner.
When it’s time to close the transaction (because either you want to close it or the owner of the shares wants to sell them, so you have to give them back), you must return the number of shares you borrowed (in this case, 100 shares).
If you buy back the 100 shares at $40 per share (remember that you shorted this particular stock because you were sure its price was going to fall) and those 100 shares are returned to their owner, you make a $1,000 profit.