Let's say you're sitting at a bar, and the person next to you really likes the watch you're wearing. They proceed to offer you $150 for the watch. This is awesome except the watch is not yours – you're just borrowing it from a friend. You're not exactly sure of the watch's retail value, but you know which store sells them and by your estimation, $150 is probably an overvaluation. If you don't act now, you will miss your opportunity to sell this watch for such a high price.
You decide to sell the watch (even though you don't own it) because you know exactly where you can buy a replacement. As long as the replacement watch costs less than $150, you will get to keep the difference in price as a sweet little profit. If the replacement watch costs more than $150, then you have to dip into your own pocket for the remainder of the cost – a loser of a deal.
This scenario is the same concept behind short shares of stock. When shares are available, you can borrow them from somebody else and sell them in the market Then later, when you decide to close the position, you can buy the shares back from the market and return them to the owner If you can buy the shares back for cheaper than you originally sold them, you get to keep the difference in price as profit. If the shares have gotten more expensive, you will have to pay the difference and buy them back for a net loss. Take note that short shares also incur costs which vary based on product and availability. Each product is categorized by the availability of its shares: Easy-to-Borrow (ETB), Hard-to-Borrow (HTB), and None-to-Borrow (NTB). Be aware, if the shares become HTB/NTB while you are short, the interest rate can get very, very large.
Short Shares and Dividends
One last thing to note about short stock positions are dividends. If you are short shares on the you will be required to pay the dividend amount per share to the long side. When dividends are paid, the stock value decreases by the same amount so you are not actually losing any money when this happens. Still, it can look a bit messy from an accounting standpoint so many short-sellers like to avoid dividends when possible. At Tastyworks, the payment process happens automatically, so no action is required unless you do not have sufficient funds to fulfill the amount of the dividend.