Making Sense of Short Selling

The Securities and Exchange Commission is cracking down on short sellers by temporarily banning the short selling of the shares of nearly 800 companies "to protect the integrity and quality of the securities market and strengthen investor confidence," the agency said in a statement Friday morning. Short sellers have been blamed for exacerbating the steep declines in stocks including Lehman Bros. and AIG.

So how does short selling work? Instead of trying to profit from a stock's rise, a short seller essentially gambles on a stock's drop. Here's the process: A trader borrows shares of a stock, then turns around and sells them. The goal is to buy the stock back at a lower price before returning it to its owner, pocketing the difference. Hedge funds are big fans of shorting stocks.

Naked short selling is the practice of shorting a stock without even borrowing shares. In July, the SEC banned naked short selling in the stocks of Lehman, Fannie Mae, Freddie Mac, and 16 securities firms.

Here's an interesting look at how the short-selling ban might boost ETFs.

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