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Investor Bulletin: An Introduction to Short Sales

The Securities and Exchange Commission’s (SEC) Office of Investor Education and Advocacy is issuing this Investor Bulletin for investors to provide them with the basics, including some of the potential risks, of short sales.

What is a short sale?

short sale generally involves the sale of a stock you do not own (or that you will borrow for delivery). Short sellers believe the price of the stock will fall, or 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. Investors may use short selling for many purposes, including to profit from an expected drop in a security’s price, to provide liquidity in response to unanticipated buyer demand, or to hedge the risk of a long position in the same security or a related security. 

Example of a short sale.

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 and immediately sells them in a short sale. Later, Company A’s stock price declines to $40 a share, and 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 $20 a share (minus transaction costs such as commissions and fees). However, if the price goes up from the original price, the investor loses money.  For example, if the stock price increases to $80 a share, and 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 transactions costs such as commissions and fees). 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.


How does short selling work?

Typically, when you sell short, your brokerage firm loans you the stock. The stock you borrow comes from either the firm’s own inventory, the margin account of other brokerage firm clients, or another lender. As with buying stock on margin, your brokerage firm will charge you interest on the loan, and you are subject to the margin rules. If the stock you borrow pays a dividend, you must pay the dividend to the person or firm making the loan.

Are short sales legal?

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 generally prohibited.  Some examples of prohibited manipulation include:

  • engaging in a series of transactions to create actual or apparent active trading in a security; or
  • 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 two-day settlement period. As a result, the seller fails to deliver securities to the buyer when delivery is due (known as a “failure to deliver” or “fail”).

Failures to deliver may result from either a short or a long sale. 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.

“Naked” short selling is not necessarily a violation of the federal securities laws or the Commission’s rules. Indeed, in certain circumstances, “naked” short selling contributes to market liquidity.  For additional information on “naked” short sales please read the Office of Investor Education and Advocacy’s publication “Key Points About Regulation SHO” located on the SEC’s website at:

What is Regulation SHO?

Regulation SHO was adopted to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938 and to address concerns regarding persistent failures to deliver and potentially abusive “naked” short selling.  Compliance with Regulation SHO began on January 3, 2005.  For additional information regarding Regulation SHO, please read the final adopting release for Regulation SHO, subsequent amendments to Regulation SHO, and other key documents and information relating to short sale regulation that are available on the SEC’s website at:

Who Do I Contact If I Have Questions about Short Sales or Regulation SHO?

If you have additional questions regarding short sales or Regulation SHO please read the Office of Investor Education and Advocacy’s publication “Key Points About Regulation SHO” located on the SEC’s website at:  You should also feel free to contact the SEC’s Office of Investor Education and Advocacy at 1-800-SEC-0330. 

The Office of Investor Education and Advocacy has provided this information as a service to investors.  It is neither a legal interpretation nor a statement of SEC policy.  If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.

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