Naked Shorting Explained: Risks & Implications for Investors

Naked shorting is when an investor short sells a security without borrowing the security first. Here are the basics of naked shorting and what it means to investors.

Naked Shorting

When an investor decides to go short on a stock sale, they typically have to borrow the shares or agree to borrow them. Regardless of the arrangement, the shares are supposed to be reserved for the person that goes short. However, when you utilize naked shorting, you are actually doing this without having access to the shares. Therefore, if you actually need access to the shares, you will not find them. Technically, this is an illegal stock trading practice. However, with the increase in electronic trading in the stock market, it happens more than investors would like.

Investment Impact

If you are involved in a transaction that turns out to be a naked short, the broker will typically leave the order open until it can be fulfilled. This practice can actually have a negative impact on the market as a whole. Large investors that wish to influence the market, could potentially short a large number of shares without having to actually gain access to them. This could drive down the price of a stock without having to adhere to the laws of supply and demand.