A short sale occurs when someone borrows a security (or a futures contract) from a broker and sells it, with the understanding that he or she will later buy it back (hopefully at a lower price) and return it to the broker. Investors use short selling (or "selling short") to try to profit from the falling price of a stock.
For example, if an investor believes stock x is overpriced and will fall, he might want to sell short 100 shares of x. His broker will borrow the shares from someone who owns them with the promise that the investor will return them later. The investor immediately sells the borrowed shares at the current market price. If the price drops, he "covers" the short position by buying back the shares, and his broker returns them to the lender.
The profit is the difference between the price at which the stock was sold and the cost to buy it back, minus commissions and expenses for borrowing the stock. If the price goes up, however, the potential for loss is unlimited, because at some point the investor must replace the 100 shares of x he sold.
Short Sales Prohibited in UK and US in 2008
On September 18, 2008, the board of the Financial Services Authority (FSA) announced it would introduce new provisions to its Code of Market Conduct to prohibit the active creation or increase of net short positions in publicly quoted financial companies. The goal was to protect the fundamental integrity and quality of markets during disorderly market conditions. The new provisions were implemented at midnight.
One day later, the U.S. Securities and Exchange Commission said it would temporarily ban investors from short selling 799 financial companies. The temporary ban, aimed at helping restore falling stock prices that shattered confidence in the financial markets, took effect immediately.