How Short-Selling Works

“Short-selling is on the decent-sized list of practices which seem bizarre to civilians but to insiders are a routine feature of how modern markets work. A short-seller borrows shares in a company, and then sells them, with the intention of buying them back at a cheaper price, returning them to the lender, and trousering the profit. Say you decide that, to take one purely hypothetical example, News Corp is overvalued because — oh, I don’t know, just to make something up — because all its senior management are going to go to jail. The current price is $15.80 and you reckon it’s heading for ten bucks. So you find a willing lender, borrow one million shares with an agreement to return them on a specific date, and then you sell them. Notice that this selling is not a neutral event: by dumping $15.8 million of News Corp stock you actively help to drive prices down. Critics of short-selling point out that this shades into a form of market manipulation, which is illegal. A short-seller isn’t just betting on an outcome, he (it’s usually a he) is trying to bring it about. Anyway, some months pass, the News Corp execs are charged with multiple malfeasances, the stock tanks to $10, you buy back the million shares — this is called ‘covering the short’ — and give them back to the lender.”
 — John Lanchester explains short-selling in an extremely depressing analysis of our horrible economic outlook.