An investor believes that ABC Corp is trading higher than they believe it should be at $10.00. The investor then sells ABC Corp. at $10.00 from stock they have borrowed. If and when ABC Corp. share price starts to decline and settles to where the investor believes is a more reasonable price of the company, say $7.50, they then buy the stock that they sold at $7.50, return the shares borrowed to the lender with the shares they bought, thus making a $2.50 profit. (1000, shares sold at $10.00 = $10,000, then purchase the 1,000 shares previously sold at $7.50 = $7,500 or a $2,500 profit).
An investor under Exchange rules is also required to put up cash margin: a percentage of the sale amount. While this varies from institution to institution, two different examples of this could be as follows:
Sale amount $10,000 or $5,000 - 50% margin cash requirement when shorting, until such time as the short position is covered (bought back). This is to protect the institution from losses should the shorted security rise in price instead of drop, and the investor therefore have to be bought in at a higher price than where they sold short.
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