What Is Short Selling? — In Plain Words
This page explains one idea only: what short selling is.
It follows one official source. That source is an Investor Bulletin from the U.S. Securities and Exchange Commission (SEC), on Investor.gov. The bulletin is called “An Introduction to Short Sales.” It was updated on September 9, 2026.
This page does not teach a strategy. It does not say when to short a stock. It does not name any stock as a suggestion. It does not recommend anything.
Short answer: In the SEC’s words, a short sale generally involves “the sale of a stock you do not own” — or a stock you will borrow for delivery. The seller borrows shares, sells them, and later buys shares back to replace the borrowed shares. If the price fell, the seller profits on the difference. If the price rose, the seller loses. The SEC warns that shorting a stock leaves an investor open to the possibility of unlimited losses.
This page is general information only. It is not financial advice.
What is a short sale?
The SEC says a short sale generally involves the sale of a stock you do not own, or that you will borrow for delivery.
The bulletin says short sellers believe the price of the stock will fall. Or they are seeking to hedge against potential price volatility in securities that they own.
If the price of the stock drops, short sellers buy the stock at the lower price and make a profit.
If the price of the stock rises, short sellers will incur a loss.
The bulletin says investors may use short selling for many purposes. Those purposes include profiting from an expected drop in a security’s price. They also include providing liquidity in response to unanticipated buyer demand. They also include hedging the risk of a long position in the same security or a related security.
How short selling works, step by step
The bulletin describes the steps in this order:
- Borrow shares. Typically, when you sell short, your brokerage firm loans you the stock.
- Sell the shares. The borrowed shares are sold in a short sale.
- Later, buy shares back. The seller buys shares back on the open market.
- Return the shares. The shares bought back replace the borrowed shares.
The bulletin says the stock you borrow can come from three places. It can come from the firm’s own inventory. It can come from the margin account of other brokerage firm clients. Or it can come from another lender.
The bulletin says your brokerage firm will charge you interest on the loan, as with buying stock on margin. You are also subject to the margin rules.
The SEC’s own example
This is the worked example printed in the bulletin. The company in it is called “Company A.” It is not a real stock pick.
An investor believes that there will be a decline in the stock price of Company A.
Company A is trading at $60 a share. So the investor borrows shares of Company A stock at $60 a share. The investor immediately sells them in a short sale.
Later, Company A’s stock price declines to $40 a share. The investor buys shares back on the open market to replace the borrowed shares.
Since the price is lower, the investor profits on the difference. In this case that is $20 a share, minus transaction costs such as commissions and fees.
The bulletin then gives the other outcome. If the price goes up from the original price, the investor loses money.
If the stock price increases to $80 a share, the investor must buy back the shares on the open market to replace the borrowed shares.
The investor would suffer a $20 loss per share, plus transaction costs such as commissions and fees.
The biggest risk: unlimited losses
The bulletin puts this warning in bold. Here it is in the bulletin’s own words:
“Unlike a traditional long position — when risk is limited to the amount invested — shorting a stock leaves an investor open to the possibility of unlimited losses, since a stock can theoretically keep rising indefinitely.”
In plain words: with a normal purchase, the most you can lose is the amount you put in. With a short sale, the bulletin says the loss has no set limit, because a stock price can keep rising.
Who gets the dividend?
The bulletin answers this in one sentence.
If the stock you borrow pays a dividend, you must pay the dividend to the person or firm making the loan.
So the short seller does not keep that dividend. The short seller must pay it to the lender.
Are short sales legal?
The bulletin says: although the vast majority of short sales are legal, abusive short sale practices are illegal.
Short sales used to manipulate the price of a stock are prohibited.
The bulletin gives two examples of prohibited manipulation:
- Engaging in a series of transactions to create actual or apparent active trading in a security.
- Depressing the price of a security to induce other investors to purchase or sell the security.
What are “naked” short sales?
In a “naked” short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard one-day settlement period.
As a result, the seller fails to deliver securities to the buyer when delivery is due. That is known as a “failure to deliver” or a “fail.”
The bulletin says failures to deliver may result from either a short sale or a long sale.
The bulletin also says there may be legitimate reasons for a failure to deliver. For example, market makers who sell short thinly traded, illiquid stock in response to customer demand may encounter difficulty in obtaining securities when the time for delivery arrives.
The bulletin says “naked” short selling is not necessarily a violation of the federal securities laws or the Commission’s rules. It says that, in certain circumstances, “naked” short selling contributes to market liquidity.
What is Regulation SHO?
Regulation SHO is the SEC rule set the bulletin points to for short sales.
The bulletin says Regulation SHO was adopted to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938.
It was also adopted to address concerns regarding persistent failures to deliver and potentially abusive “naked” short selling.
Compliance with Regulation SHO began on January 3, 2005.
Two cross-references
FinWhiz (finwhiz.us) shows FINRA short-interest figures and flags on its stock pages; that is market data, not advice, and it is not this explainer.
For plain-words warnings about AI stock pickers and AI trading claims, see the companion page: AI Stock Pickers and AI Trading Claims — In Plain Words.
Sources
Investor.gov (U.S. Securities and Exchange Commission, Office of Investor Education and Assistance) — “Investor Bulletin: An Introduction to Short Sales,” updated September 9, 2026. https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-51 Read in full. Every definition, step, example, figure, risk warning, and legal point on this page comes from this bulletin.
The bulletin’s own closing note, printed here so its status is clear: “This Investor Bulletin represents the views of the staff of the Office of Investor Education and Assistance. It is not a rule, regulation, or statement of the Securities and Exchange Commission (‘Commission’). The Commission has neither approved nor disapproved its content.”
Checked November 2026.
This page is general information only. It is not financial advice.
This page only explains what short selling is, in the SEC bulletin’s own framing. It decides nothing about any stock, company, or trade.