Borrowing shares and selling them with the intent to buy them back later at a lower price, profiting from a decline - the equity equivalent of a short position.
Short selling involves borrowing shares (from a broker's inventory or other clients) and selling them immediately at the current market price. If the stock falls, the short seller buys the shares back at the lower price, returns them to the lender, and pockets the difference minus the borrow cost. If the stock rises, the short seller faces mounting losses - theoretically unlimited, since a stock can rise without limit while the maximum profit on a short is capped at 100% (if the stock goes to zero).
Borrow costs vary significantly: heavily shorted stocks with limited float trade at 'hard to borrow' rates that can reach 50–100%+ annually, materially eroding the profitability of short positions held for more than a few weeks. The cost to borrow is charged daily. Short interest - the percentage of a company's float currently sold short - is reported bi-weekly and is a key sentiment indicator. Very high short interest (above 20–30% of float) creates short squeeze risk: if the stock rallies, short sellers must buy to cover losses, further driving the price up in a feedback loop.
Regulatory restrictions on short selling vary by jurisdiction. Some regulators impose temporary short-selling bans during market stress (as occurred during COVID-19 volatility). Uptick rules (requiring a short sale to be executed at a price above the last trade) were abolished in the US in 2007 but similar rules apply in some other markets. In most retail contexts, short selling is implemented through CFDs or options rather than actual stock borrowing.
Worked Example
A trader short-sells 100 shares at USD 80 (total: USD 8,000). Borrow rate: 3% annually = USD 0.66/day for this position. Stock falls to USD 65. The trader buys back 100 shares for USD 6,500. Gross profit: USD 1,500. Less 30-day borrow cost: 30 × USD 0.66 = USD 19.80. Net profit: ~USD 1,480.