Stock Market Investors » Glossary of Stock Terms » What is Naked Short Selling?

What is Naked Short Selling?

Many investors manage to make money from the decrease of stock prices thanks to the advanced investing technique known as short selling.

Basically, when short selling investors sell stock that they do not own but have been promised to get. Here is how: your broker lends you stock that can come from the brokerage firm's own inventory, another firm, or one of the other firm's customers. You sell the shares in the hope that the stock price will drop and the proceeds are credited to your account. At some point in the future you must buy back the same number of shares, hopefully at the expected lower price, and return them to your broker. If everything has gone according to plan you would have made a profit on the difference. If, however, the stock price have risen you would have lost money.

Now, "naked short selling" is something different. When naked shorting, the seller skips the step of borrowing the securities in time to deliver them to the buyer within the mandatory three-day stock settlement period. Thus, when delivery is due the seller fails to deliver the securities to the buyer which is known as "failure to deliver", or "fail".

The seller may fail to deliver for legitimate reasons such as human or mechanical errors, or processing delays when transferring the securities.

Naked short selling is not always violating of the federal securities laws or the Securities and Exchange Commission's rules, though when effected to manipulate the price of a stock it is prohibited.

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