More in depth explanation if your interested below:
This type of stock transaction reverses the typical order of the transaction so that the sale of the security occurs first. Since the sale of the stock comes before the purchase of the stock, the short seller is actually selling stock that they do not own. This sounds great doesn't it? The reason that someone sells a stock short is that they think that the price of the stock will fall in the future. If the stock price does not drop, then no, this is not a great thing, if it does drop, then yes this is a good thing.
For example, if you purchase 100 shares of Motorola stock at $50 a share for $5,000, and the per share price drops to $40 ($4,000), you just lost $1,000 or 20% of your investment. Well, if you sold the stock short at $50 and repurchased the shares for $40, you'd make $10 per share (or $1,000).
Now how does this actually work? The short seller borrows the shares from a share holder, typically a broker (who borrows them from either another broker or from an existing shareholder). The short seller actually does not pay for the stock until a later time, but must deposit with the broker an amount equal to what is called the margin requirement (typically less than 100% of the value of the stocks). This money will protect the broker. The broker receives the money from the buyer of the stock as well as the margin from the short seller. The short seller receives nothing. If the stock drops to a low enough price (for the short seller), the short seller buys the stock, which is returned to the broker and the loan of the stock is repaid. The short seller receives the margin as well as the $1,000 profit from the broker.
If the stock price goes up during this period, then the short seller's deposit will be insufficient to cover the purchase of the share price and the broker will use $1,000 of the margin requirement plus the $5,000 from the initial buyer to purchase shares to pay back the original owner of the sold stock and return the remaining margin requirement to the short seller."
