Saturday, November 11, 2017 2:47:16 PM
Borrowing Stock: When you enter an order to sell a stock short, you must tell the broker you're shorting the stock. The reason? The broker needs to be able to borrow the stock from someone so that it can deliver to the buying party the stock you want to sell. Think about it. You want to sell something to someone who wants to buy it. They want to own the stock. So you have to be able to deliver stock to the buyer. But you don't own the stock. You're shorting it. Where does the stock come from that the buyer gets? It comes from another account that has the stock and has signed a margin agreement with the broker. If an account has a margin agreement, it says, in the fine print, that the broker can borrow stock from the account to use for its own purposes. It's standard practice in the industry. That's why brokers like margin accounts. You should like them, too, because borrowing money in your margin account is probably the cheapest way to borrow money. However, having that margin account allows the broker to use the stocks in your account for its own purpose unless you don't give the broker that right. But most investors do.
So the broker can then go into an account, borrow the shares needed to fill the buy side of the trade (remember: the broker must deliver stock to the buyer of your stock within three business days of your trade). That's why you have to tell the broker you're selling the stock short. If the broker can't borrow the stock because there isn't enough stock around to borrow, then you won't be able to short the stock. Every broker keeps a list of stocks that are not eligible for shorting. Once you try to enter your order to sell short, you'll find out quickly if your stock is on that list. Usually, the smaller cap stocks are the ones that are hardest to short. Difficult for the investor to short but not difficult for the marketmakers to borrow the investor's shares to short themselves.
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