Ok, I have received a few questions about shorting so let me explain it in detail for anyone that is confused about it. Everyone knows what to do when they find stocks (or other financial instruments) that they believe are going to advance in price: you buy them. But how can you profit from stocks that you believe will decline in price? Answer: shorting.

You short stocks by selling stocks that you do not own (at least not in the same account). That's right, shorting enables you to sell stock that you do not own and buy it back at a later time, ideally at a lower price. How can you sell a stock that you do not own? You borrow it...but as is the case with anything that you borrow, you are obligated to return it at a future date and you do this by buying it back (this is called covering your short) and returning it to it's original owner. If you are able to cover the short (buy the stock back) for less than it cost when you sold it, this difference in price becomes your profit. The original owner is "none the wiser" because it is all handled electronically and anonymously. In summary, a short sale reverses the order of a typical stock purchase: stocks are sold first and bought later.

Short selling is a marginable transaction and that means that you must open a margin account to sell short. This is the same account you would use if you want to use your stocks as collateral margin to trade in the markets. When you open a margin account, you must sign an agreement with your broker and this agreement says you will maintain a cash margin or offer your stocks as margin.

Unlike a purchase transaction, which involves two parties (the buyer and the seller), shorting involves three parties: the original owner, the short seller, and the new buyer. The short seller borrows shares from the original owner, and immediately sells them on the open market to any willing buyer. To finalize (cover) the short sale transaction, the short seller must then go out into the market and buy the same amount of shares as he/she sold so that the broker can return them to the original owner.

While your short sale is outstanding, your account will be charged interest against the value of the short position. If the stock you shorted goes up in price, or the value of the stock you are using as collateral goes down in price, so that your collateral is less than the "maintenance" requirement, you will be required to add money to your margin account or buy back what you sold short.

Short sales, like any trade, should be planned well before executed and should be managed with carefully chosen stops to reduce risk.

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