Short Selling/Naked Short Selling - What is it?

**On the NEWS**: Merkel introduces ban on naked short selling from midnight tonight  
**On the NEWS**:  There are $250 billion in naked CDS outstanding; they have 4 hours to unwind . . .





There was a great explanation on short selling by mikla on ZeroHedge on Tue, 05/18/2010 - 13:14
#358589

Shorting (good) and "naked shorting" (bad) are different.

Shorting:  (example), A stock's current market price is $100.  I think it should sell for $80, so I won't buy it.  However, I'll sell it for $100, because I think the market will soon figure out it should be priced at $80 (and I'm willing to incur risk while I wait):

1. I "borrow" a share to sell.
2. I sell it for $100 (the current market price).
3. I wait until the share drops to $80.
4. I buy a share for $80 (the current market price).
5. I give the share to the guy in (1) that let me borrow his, "covering" my short, to result in a net profit of $20.

For shorting, I may reap the benefit of knowing the "better" price of the stock.  I incur the risk that if it never drops in price, I'll lose money when I need to "cover my short" at some point, at market price, to give it back to the guy from which it was borrowed.  The market benefits through liquidity because I wouldn't play at $100, but I'm willing to incur a risk for an expected future price around $80 (e.g., a market buy/sell transaction occurs now when it otherwise would not).

Naked Shorting:  I like running naked through the woods because I like the light breeze on my hot loins and the expressive freedom it exudes.  From "shorting" (defined above), to do "naked shorting", skip steps (1), (4), and (5).
Naked shorting is illegal for you-and-me, but is often done in dark pools by the big investment houses.  The net effect is I can "sell" a zillion shares that don't exist, driving down the price of "real" shares.  I never cover (never buy what I've sold).  All I'm doing is distorting market price, with zero capital and risk up-front, and pocketing cash, by putting in no cash and carrying no risk (if I don't get caught).  While illegal, this is common these days for predatory market manipulation (google the big topic).
For example, if a company has 5,000 shares of stock TOTAL, you can go to your online brokerage account and buy 6,000 shares of that stock.  Impossible, but your trade will go through (that's only possible through fraud).
Shorting:  Good.  Naked shorting:  Bad.
At various times, markets have banned shorting (that's stupid).  Naked shorting is always illegal, but regulators sometimes puff up their chests to pretend they are going to address that as a problem with new weird regulations and arbitrary timelines.