HOW SHORT SELLING WORKS
Plain English
Short selling lets you profit when a stock falls. You borrow shares from your broker and sell them. Later, you buy them back (hopefully cheaper) and return them. The risk: if the stock goes UP instead of down, your losses are theoretically unlimited.
Going deeper
The mechanics of short selling: (1) You request to borrow shares from your broker's inventory or other clients' shares. (2) You immediately sell those borrowed shares at the current market price. (3) Your account holds the cash from the sale plus additional collateral. (4) Later, you buy the same number of shares in the market (covering). (5) You return the shares to the lender and keep or pay the difference. Short sellers pay a 'borrow fee' (typically 0.5-3% annually, but can be 100%+ for heavily-shorted stocks). Hard-to-borrow stocks have higher fees and may be unavailable. Short interest ratio (days to cover) measures how many days of average volume it would take for all shorts to cover. High short interest = potential squeeze.
Examples
Mechanics Step by Step
Stock at $50. You borrow 200 shares and sell them: receive $10,000. Stock drops to $30. You buy 200 shares for $6,000 and return them to the lender. Profit: $4,000 minus borrow fees and commissions.
The Unlimited Loss Risk
You short 100 shares of a biotech at $20 ($2,000 exposure). The FDA unexpectedly approves their drug. Stock surges to $200. To close your short, you must buy at $200: cost $20,000. Loss: $18,000 — 9x your original short exposure.