Short selling is betting that the price of an asset (e.g., a stock) will go down. It goes like this:
I think the stock of company A will go down, therefore I want to short the stock of company A. In order to do so, I approach an investor who owns the stock of company A and ask to borrow 10 units of the stock. The price of stock is £1 per share. I take my borrowed stock (worth £10) and sell it in the marketplace (for £10). Then, I wait for the stock price to go down to, say, 80p, and I buy back 10 units of the stock (for £8). I go back to the original owner of the stock from whom I borrowed it, and I give them back their 10 shares. Having sold the stock for £10 and later bought it back for £8, I have made £2 from the fall in the price of the stock.
Importantly, I didn’t borrow £10, so I don’t owe the lender £10. I borrowed 10 shares, so I owe them back 10 shares.
If the price of the stock were to have gone up, I would have lost money. Since there’s no upper limit for a stock price, potential losses when shorting a stock are unlimited. Since a stock price can only go down to zero, potential gains from shorting a stock are limited to the starting price of the stock.
Why would someone lend me their stock in the first place? Usually, lenders of stock are passive investors following a set of investment rules which force them to own the stock. Since they have to own the stock anyway, some of them decide to loan out some of their stock. Technically, the borrower of the stock will pay the lender a small fee for borrowing their stock, similar to how you would pay interest on a loan.
We’ve tried to keep this description as direct and uncluttered as possible, but please leave a comment if you’d like us to elaborate.
To the pound 