What are "Short Selling" and "Buy to Cover"?

Short selling means borrowing some shares and selling them with the promise to buy them back later. Buying them back later is called "buy to cover." You make money if the stock goes down.

Example: Stock is at 100. You short it, so you sell it at 100. Let's say it goes to 90. You buy it back and return the shares. So, you make the 10 because you bought at 90 and sold at 100. You lose money in the opposite case where the stock goes up.

This is taking on some extra risk! When a stock purchaser signs a margin agreement with a broker they are giving that broker the right to "lend" any shares in the account to another investor to short. The loaning investor never even knows that the shares have been loaned. The one borrowing then sells those shares in the market. These loaned shares must be given back, so eventually the borrower must buy the shares in the market to replace them. If the price of the shares is lower than the original sale price, the difference is a profit and can be kept. If the price of the shares is higher, then the borrower experiences a loss. A buy to cover is when someone buys shares to replace borrowed shares. One thing to realize is that your broker follows something called the "Buy In Rule." This means that the broker has a right to buy the shares in the market using your account at their discretion. For example, you short sell stock A at $100. The shares they shoot up to $120/share. The brokerage company buys the stock in the market for $120 then hands you the bill for it. It's one of the reasons that short selling is riskier

Short Selling is the selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.
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