Most people think how you make money in the stock market is by buying stocks when they are cheap, then selling the stocks when they go up in value, and the difference between the low price and the high price is profit. Of course this is true, but what a lot of people dont realise is that you can make money as a stock goes down in value, and infact you can make MORE money as a stock goes down. Characteristically stocks tend to go down in value (crash) faster than they go up in value. Short selling is also a leveraged vehicle, which accellerates profits (and losses) even more. IE: you only need 20% of the capital invested in any particular trade (unless the trade loses 20% in which case you not only deserve a kick in the bum, but your broker will ask you for more money).
Here's an example: I have found a stock named XYZ and i believe that it is trading at a very high price, lets say $10. I have done my analysis on the stock and all the indicators are telling me that price should come down to around $9. I then ring my broker and ask him to SHORT sell 10,000 XYZ shares for $10. That is $100,000 worth of stock !! but the good thing is, you only need $20,000 to make the trade. You can do your own maths to work out how much you need for lesser or greater trades than that. So we have short sold the stock at $10 and as it turns out we got the trade correct and price moves down to $9. We then call the broker again and ask him to COVER 10,000 XYZ shares at $9. Thats $10,000 profit from a $20,000 investment, and yes that equates to 50% !! Had you placed the trade without the leverage effect and you could only afford $20,000 worth of shares, you would have made $2,000 and 10%. Thats the power of leverage ! Conversly of course, you can lose just as quickly if you get the trade wrong :o(
So, I can hear you asking "how can I sell something that i dont own?" well in short, you borrow them from your broker. IE: you borrow the shares from your broker, because they have a long term view or whatever the case may be, and you sell them on the market, then the "covering" part is where you are buying them back at a cheaper price to give them back to your broker. You dont need to know all the technicallities of it, basically all you need to know is that you sell the stock because it's too expensive, and you buy it back when you think it's cheap. It's that easy :o)
There's just a couple of things you need to keep in mind about short selling. If you have a short possition on a stock, and the dividend date comes around while you possition is still active, you have to pay the dividend to your broker. As a rule we never short sell a stock across a dividend day unless the trade is already in profit and the dividend is a small one, in which case your broker will deduct the dividend from your profits. Also bear in mind that not EVERY stock can be short sold, however almost all of the ASX Top 200 companies can be.There are limited brokerage firms that have the short selling facility, we have no hesitation in recomending Citigroup