Legal Definitions - sale short

Definition: A sale of a security that the seller does not own or has not contracted for at the time of sale, and that the seller must borrow to make delivery. Such a sale is usually made when the seller expects the security's price to drop. If the price does drop, the seller can make a profit on the difference between the price of the shares sold and the lower price of the shares bought to pay back the borrowed shares.

Example: John believes that the stock of XYZ company will decrease in value. He decides to sell short 100 shares of XYZ company at $50 per share. John does not own the shares, so he borrows them from his broker and sells them in the market. If the price of the shares drops to $40 per share, John can buy 100 shares at $40 to pay back the borrowed shares, making a profit of $1,000 ($50 - $40 = $10 profit per share x 100 shares).

This example illustrates how a short sale works. John sells shares he does not own, hoping to buy them back at a lower price to make a profit. Short selling can be risky because if the price of the shares increases instead of decreasing, the seller will have to buy them back at a higher price, resulting in a loss.