The purchasing of the stock after short selling is called 'Short Covering', 'covering the short' or 'covering the position'. If the price of the scrip declines at the time of short covering, the short seller will get profit as the cost of repurchase is less than the price of selling.If the price of a scrip increases prior to repurchase the short seller will incur a loss. The risk in short selling is that the potential loss of a short sale is unlimited. The short seller requires to keep a minimum margin to cover losses and keep the position. If the trader fails to keep the margin the broker or counter party may liquidate the position.
On speculative markets traders uses the fluctuations to short a scrip to quickly make big profits.It is like gambling and in some cases it may result in heavy losses and as I mentioned above the loss of a short is theoretically unlimited.So one must keep strict stop loss to restrict the losses.
In short selling, when you sell a financial instrument the broker will lend it to you from their own account or from some body else account (who is a customer of the firm) or from another brokerage to you.That is, you are borrowing the scrip and selling to some body else.You can hold the short as long as you want by keeping the margin. Some times interest may be charged to margin accounts. If the lender wants the stock back you borrowed from him you may either have to cover the short or borrow from another lender.
In short, You are not the owner of the financial instruments you have sold. You must have to pay the dividends* or rights declared during the period of short to the lender. In case of a stock split you must have to return the increased number of shares at lower price. That is if the stock splits in a ratio 2:1 you have to return twice the number of shares at half the price.
Short selling plays a big role in day trading and it safer than short term short selling as the over nigh risk is not present. Hedge funds and large institutions also uses short selling to make some money. Some wealthy investors also uses short selling to make profit. How ever a short trader must be a dedicated person and he must be aware of the market condition and general conditions to avoid possible losses.
*The actual dividend paid by the company goes to the new buyer. The lender of the financial instrument who holds the shares in margin account also expects dividend (He is unlikely to be aware that his shares are lent out for short selling). There fore the short seller have to pay the dividend amount to compensate.
