I'm trying to wrap my head around short selling. Online the explanations i found talk about borrowing a stock from your broker, selling it at a high price then waiting for the stock to drop in price and buying it back for that low price, so you can return the stock to its original owners and pocket the difference, this i get. my question is, how can you sell something that you borrowed, how can you sell something that is not yours. like for example if i borrowed my friends car, i can't sell it because i wouldn't have the pink slip, so how can i sell stocks that i don't own? Thanks in advance.
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If you had an agreement with your friend such that you could bring back a substantially similar car, you could sell the car and return a different one to him. The nature of shares of stock is that, within the specified class, they are the same. It's a fungible commodity like one pound of sand or a dollar bill. The owner doesn't care which share is returned as long as a share is returned.
I'm sure there's a paragraph in your brokerage account terms of service eluding to the possibility of your shares being included in short sale transactions.
quid
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The original owner of the shares can pledge their shares to be short, and they earn interest from lending their shares.
The conditions of this arrangement are detailed in standard agreements all market participants sign with their broker, or clearinghouse, or with the exchange, or with the self regulatory agency.
Stocks within the same class are identical, despite someone's sentiment to an old share certificate that their grandparents gave them, and as such can be sold and returned to the beneficial owner multiple times with no difference.
That is how it is supposed to work anyway, as naked shorting involves selling fictional shares that have no beneficial owner. So there are market inefficiencies in this practice, but the agreements between market participants are sound and answers your question about how.
CQM
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My take on this is that with any short-selling contract you are engaging in, at a specified time in the future you will need to transfer ownership of the item(s) you sold to the buyer.
Whether you own the item(s) or in your case you will buy your friend's used car in the meantime (or dig enough gold out of the ground - in the case of hedging a commodity exposure) is a matter of "trust". Hence there is normally some form of margin or credit-line involved to cover for you failing to deliver on expiry.
Marc E.
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