As an investor, you might at some point decide that a certain stock is overvalued and is due for a fall in stock price. In such a case, an investor can sell short a stock. The investor arranges to have the broker borrow the stock from another investor; then the stock is sold. The broker holds the cash from the sale as collateral. If the stock goes down, then you, as the investor that is selling short, can buy back the stocks at the lower price and keep the difference as profit. Therefore, you receive the cash collateral, less the cost of the repurchased stock.
Generally, there is no charge for borrowing stock, although sometimes a premium is charged. When borrowing, the investor must deposit $2000 or the required initial margin, whichever is the greater. This deposit is returned when the investor buys back the stock and it is returned to the rightful owner. Because the stock is not actually owned by the stock lender while you are short selling it, you must pay the lender any dividends which are declared during the period the stock is shorted.
The SEC only allows short sales to be executed on an uptick. This means that the stock is increasing on the exchange. If the stock is decreasing, then the investor is not allowed to sell it short.
When selling a stock short, you must be very careful to understand that there is no limit to the losses involved. When buying stock, the limit of the your loss is the price of the share; that is, the maximum per share loss is the price of the share. However, in the case of shorting, the stock can theoretically go up indefinitely and has no limit. Also, if a large number of short sellers are trying to close out their position by purchasing a stock, the prices might be driven to very high levels, thus increasing your losses.