Short-selling explained

SHORT-SELLING is where investors bet on a stock or security falling in value, rather than the conventional practice of buying equities whose price is expected to increase.

Investors borrow the shares they wish to "short", normally from a broker, and sell it before it falls in value.

When the time comes for them to return the stock, they buy the same quantity at the lower value, making a profit on the difference between the price at which they sold the shares and the price at which they bought them back.

For example, the investor borrows 1,000 shares in company X at €4 and sells them at this price, making €4,000. They buy back the stock at €3 a share, or €3,000, making €1,000 profit.

The practice is riskier than conventional investing. There is no ceiling on how high share prices can go, so losses are potentially limitless.

At the same time, as the price can never fall below zero, the maximum potential gain is 100 per cent.

In addition, as the stock is borrowed, the lender will normally require the borrower to maintain a minimum proportion or "margin" of its value, normally 25 per cent, in their account. I

f the shares go up, the borrower will have to increase their margin in line with this, reducing or eliminating their ultimate profit. Or they may have to repay the stock at the higher value, guaranteeing a loss on the deal. S

hort-sellers are blamed for aggravating the consequences of the credit crunch on share prices. This week, Irish authorities banned them from trading in bank stocks.

However, a number of analysts argued this week that share prices fall because conventional investors sell them, as they believe they are overvalued and cannot deliver a profit. Short-sellers simply exploit this.