What Is a Sellout?

In the context of finance and investing, the term “sellout” refers to a situation in which individuals or firms are forced to sell some or all of their assets to satisfy certain short-term obligations that cannot be met otherwise.

Sellouts can occur when an investor experiences substantial losses in a margin account. An example of a sellout would be a margin call, in which a broker forcefully liquidates a margin trader’s portfolio based on that trader’s failure to maintain adequate collateral.

Sellouts should not be confused with sell-offs, which involve a rapid decline in the prices of assets due to substantial selling pressure.

Regulations

Each country sets restrictions and regulates short-selling in its markets. In the U.S., short selling is regulated by the U.S. Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934. Regulation SHO, implemented in 2005, is the primary rule governing short selling that mandates short sales can only be executed in a tick-up or zero-plus tick market, meaning the security price must be moving upward at the time of the short sale.

According to Regulation SHO, brokers must locate a party willing to lend the shorted shares, or they must have reasonable grounds to believe that the shares could be borrowed. This prevents naked short selling, where investors sell shares they have not borrowed.
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The SEC can impose temporary short-selling bans on specific stocks under certain conditions, such as extreme market volatility.
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In October 2023, the SEC added regulations requiring investors to report their short positions to the SEC and companies that lend shares for short selling to report this activity to FINRA.
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These new rules come after increased scrutiny of short selling, particularly following the GameStop (GME) meme stock saga in 2021, when retail investors drove up the stock price, causing losses for hedge funds that had shorted the company.

Advantages and Disadvantages

If the seller predicts the price moves correctly, they can make a positive return on investment, primarily if they use margin to initiate the trade. Using margin provides leverage, which means the trader does not need to put up much of their capital as an initial investment. If done carefully, short selling can be an inexpensive hedge, a counterbalance to other portfolio holdings.

A trader who has shorted stock can lose much more than 100% of their original investment. The risk comes because there is no ceiling for a stock’s price. Also, while the stocks were held, the trader had to fund the margin account. When it comes time to close a position, a short seller might have trouble finding enough shares to buy—if many other traders are shorting the stock or the stock is thinly traded.


Conversely, sellers can get caught in a short squeeze loop if the market, or a particular stock, starts to skyrocket. A short squeeze happens when a stock rises, and short sellers cover their trades by buying back their short positions.

Pros
Possibility of high profits

Little initial capital required

Leveraged investments possible

Hedge against other holdings


Cons
Potentially unlimited losses

Margin account necessary

Margin interest incurred

Short squeezes

Short Selling Strategies

Profit
Imagine a trader who believes that XYZ stock—currently trading at $50—will decline in price in the next three months. They borrow 100 shares and sell them to another investor. The trader is now “short” 100 shares since they sold something they did not own but had borrowed.

A week later, the company whose shares were shorted reports dismal financial quarterly results, and the stock falls to $40. The trader closes the short position and buys 100 shares for $40 on the open market to replace the borrowed shares. The trader’s profit on the short sale, excluding commissions and interest on the margin account, is $1,000, based on the following calculations: $50 - $40 = $10 and $10 x 100 shares = $1,000.

Loss
Using the scenario above, suppose the trader did not close out the short position at $40 but decided to leave it open to capitalize on a further price decline. However, a competitor swoops in to acquire the company with a takeover offer of $65 per share, and the stock soars.


If the trader decides to close the short position at $65, the loss on the short sale would be $1,500, based on the following calculations: $50 - $65 = negative $15, and negative $15 × 100 shares = $1,500 loss. In this case, the trader had to buy back the shares at a significantly higher price to cover their position.

Hedge
The primary objective of hedging is protection, as opposed to the profit motivation of speculation. Hedging aims to protect gains or mitigate losses in a portfolio. The costs of hedging are twofold. There’s the actual cost of putting on the hedge, such as the expenses associated with short sales, or the premiums paid for protective options contracts.

Also, there’s the opportunity cost of capping the portfolio’s upside if markets continue higher. If 50% of a portfolio with a close correlation to the Standard & Poor’s 500 Index (S&P 500) is hedged, and the index moves up 15% over the next 12 months, the portfolio would only record approximately half of that gain, or 7.5%.

Timing and Conditions

Timing is crucial when it comes to short selling. Stocks typically decline much faster than they advance, and a sizable gain in the stock may be wiped out with an earnings miss or other bearish development. Conversely, entering the trade too early may make it difficult to hold on to the short position in light of the costs involved and potential losses, which rise if the stock increases rapidly. Short sellers commonly look for opportunities during the following conditions:

Bear Market: Traders who believe that “the trend is your friend” have a better chance of making profitable short-sale trades during an entrenched bear market than they would during a strong bull phase. Short sellers revel in environments where the market decline is swift, broad, and deep, to make windfall profits during such times.

Decline in Fundamentals: A stock’s fundamentals can deteriorate for several reasons—slowing revenue or profit growth, increasing challenges to the business, and rising input costs that pressure margins. Worsening fundamentals could indicate an economic slowdown, adverse geopolitical developments like a threat of war, or bearish technical signals like new highs on decreasing volume.

Bearish Technical Indicators: Short sales may succeed when technical indicators confirm the bearish trend. These indicators could include a breakdown below a key long-term support level or a bearish moving average crossover like the death cross. An example of a bearish moving average crossover occurs when a stock’s 50-day moving average falls below its 200-day moving average. A moving average is merely the average of a stock’s price over a set period. If the current price breaks the average, either down or up, it can signal a new trend in price.

High Valuations: Occasionally, valuations for certain sectors or the market as a whole may reach highly elevated levels amid rampant optimism for the long-term prospects of such sectors or the broad economy. Market professionals call this phase of the investment cycle “priced for perfection,” since investors will invariably be disappointed at some point when their lofty expectations are not met. Rather than rushing in on the short side, experienced short sellers may wait until the market or sector rolls over and commences its downward phase.

How Short Selling Works

Traders commonly engage in short selling for speculation and hedging. To open a short position, a trader must have a margin account and pay interest on the value of the borrowed shares while the position is open.

The Financial Industry Regulatory Authority (FINRA), which enforces the rules and regulations governing registered brokers and broker-dealer firms in the United States, the New York Stock Exchange (NYSE), and the Federal Reserve have set minimum values for the amount that the margin account must maintain—known as the maintenance margin.

A broker handles locating shares that can be borrowed and returning them at the end of the trade. Opening and closing the trade can be done through regular trading platforms with brokers qualified to perform margin trading. To short-sell, traders commonly follow these steps:

A seller opens a short position by borrowing shares, usually from a broker-dealer, hoping to repurchase them for a profit if the price declines.
The investor then sells these borrowed shares to buyers willing to pay the market price. The trader is betting that the price will continue to decline and they can purchase the shares at a lower cost.
To close a short position, a trader repurchases the shares—hopefully at a price less than they borrowed—and returns them to the lender or broker.
Traders must account for any interest the broker charges or commissions on trades.

What Is Short Selling?

Short selling is a trading strategy where investors speculate on a stock's decline. Short sellers bet on, and profit from a drop in a security’s price. Traders use short selling as speculation, and investors or portfolio managers may use it as a hedge against the downside risk of a long position.

Example of Custody Only Trading

In a typical stock transaction made through an online brokerage account, the transaction is handled electronically. Share certificates can be requested, at a cost, but are not automatically provided to the stock buyer. Instead, the ownership of the shares is tracked and recorded electronically by the DTC.

When someone purchases custody-only shares, which are far less common than shares that can be traded electronically, share certificates are generated in the buyer's name. The share certificates that were in the seller's name are canceled.

If the owner of the shares wishes to sell them, they must contact the transfer agent who will facilitate the creation of new share certificates in the new owner's name, and cancel the prior owner's certificates.

Drawbacks of Custody-Only Trading

The biggest drawback of custody-only trading is that it theoretically sacrifices some level of liquidity and efficiency. It takes more work to buy and sell shares. Investors with a particular strategy may find this downside is made up for by the prohibition against naked short selling.


Another issue arises because custody-only securities are not eligible for Depository Trust Company (DTC) nominee registration or for DTC book-entry services. However, DTC does allow for the deposit of securities under different methods; these apply to specialized asset classes such as customer-registered custodial assets, restricted shares, private placements, and limited partnership interests.

The Depository Trust Company (DTC) is the world's largest securities depository. Founded in 1973, it is a trust company that provides safekeeping through electronic recordkeeping of securities balances. It also acts as a clearinghouse to process and settle trades in corporate and municipal securities.

Understanding Custody-Only Trading

While conventional short selling involves the sale of borrowed stock, "naked" short selling refers to short sales by traders who have no intention of borrowing and then selling the stock. Rather, they simply resort to short selling without borrowing the stock or ensuring that it can be borrowed, thereby driving down the price of the stock precipitously. Since custody-only trading requires purchase and sales of physical shares only, there is no stock for short-sellers to borrow or pretend to borrow, thereby discouraging naked shorting. In 2008, the SEC banned "abusive" naked short selling in the United States.

For certain types of investors, like a hedge fund or a buy-and-hold investor, they may prefer to hold investment securities that are not subject to the speculative intentions of short-sellers. Custody-only makes sense because it prohibits speculators from driving security prices around erratically with naked short sales.

In reality though, naked shorting is not a major problem on the vast majority of listed stocks. Although, it may be more of a problem for stocks that trade over-the-counter (OTC) or aren't listed on a major exchange. These are typically small companies or penny stocks that are already highly speculative in nature.

What Is Custody-Only Trading?

Custody-only trading is a system in which shares must be registered to the holder by name (and not that of an owner's broker or custodian) and can only be traded in physical form (e.g., paper stock certificates).

If Stock Certificates Are Transferred on Death, What Is the Tax?

Whether someone is transferring a stock certificate on death or electronic shares, the tax implications are the same. That is, you are not liable for taxes on the shares you inherit when someone dies. But you might be liable for the taxes if you sell them.

Disadvantages of Issuing a Share Certificate

There are several disadvantages of issuing a share certificate.

From the company's perspective, the primary drawback comes down to time and money. Issuing paper stock certificates is labor-intensive and represents a big expense. In fact, businesses usually need an entire team dedicated strictly to managing the share certificate system.

There is a tremendous amount of tedious clerical work involved in maintaining a stock certificate system. For example, all transactions, such as a merger or spinoff, can only proceed when the paper certificates are signed and mailed to the company. Also, compliance becomes much more difficult to address.

Moreover, ownership is very difficult to keep up with, as shareholders can pass the certificates to someone else without notifying the company. It all adds up to a significant amount of back-office work to verify identities in order to sign off on the transfer of ownership. In other words, the company has to keep track of the shares at all times. This is typically done through a computer system.
Finally, if a shareholder has their paper certificate lost or stolen, it means a lot of work for the company. Specifically, the business has to find the old shares, verify ownership, put a "stop" on the paper certificates, and then issue new paper certificates. Obviously, this process is also a headache for the shareholder.

The bottom line is that documenting, tracking, and verifying transactions with paper stocks is very challenging.

What Do I Do If I Lost My Original Share Certificate?

Even without the physical share certificate, you are still the rightful owner of the stock and have a claim to all of the rights of being a shareholder.

If your share certificate is lost, accidentally destroyed, or stolen, you should immediately contact the transfer agent and request a "stop transfer." This prevents ownership of the stock certificate from being transferred to another person. Your stockbroker might also be able to help you with this process.


You will be able to get a new replacement certificate. But typically, companies will first require you to do the following:

Make a statement of facts surrounding the loss in an affidavit
Purchase an indemnity bond to protect the company against the chance that the lost certificate may be presented at a later date
Request a new certificate before an innocent purchaser requires it

Understanding Share Certificates

When companies issue shares in the market, shareholders who buy in are issued a share certificate. The share certificate basically acts as a receipt for the purchase and ownership of shares in the company. The document certifies registered ownership of shares from a particular date.

What Is a Share Certificate?

A share certificate is a written document signed on behalf of a corporation that serves as legal proof of ownership of the indicated number of shares. It is also referred to as a stock certificate.

What is the origin of the word "stocks" in finance?

The word stock comes from the Old English stocc, which means “stump, post, stake, tree trunk, or log." It is derived from the Proto-Germanic stauk-, which means “tree trunk or stalk" The word stock was used to refer to the equity instruments that represent ownership in a corporation or similar entity since the early 17th century, but the exact reason why it was used to refer to equity ownership is unclear. It could be the idea of a tree's "trunk" from which gains are an outgrowth, or it could derive from an obsolete use of the word stocc as a "money-box."

What is the origin of the word "shares" in finance?

The word shares comes from the Old English scearu, which means “a cutting, shearing, division” or “a part or division." The word shares was used to refer to the portions of ownership in a company or a financial instrument since the late 16th century, and is so called because the shareholder owns a part or division of that company or investment.

UK vs US
In British English, "shares" is more commonly used than stocks, especially when talking about individual listed companies. In American English, "stocks" is more commonly used.

In either the UK or US, however, there is no practical difference between the terms stocks and shares.

The Bottom Line

Shares and stocks are terms that are often used interchangeably to refer to the equity instruments that represent ownership in a corporation or similar entity. However, there are some subtle differences between them depending on the context, geography and culture (e.g., "shares" is used colloquially in the UK while "stocks" is far more common in the US). Shares is a more specific term that can refer to the ownership of a particular company or a type of financial instrument, while stocks is a more generic term that can refer to a slice of ownership of one or more companies or a collection of investor holdings or a portfolio. The words also have some other meanings that are related to their original senses of division and trunk. Shares and stocks are both important concepts for investors who want to participate in the equity market and benefit from its potential returns and risks.

How can I buy shares or stocks?
To buy shares or stocks, you will need to open a brokerage account with a licensed broker-dealer who can execute your orders on the stock exchange. You will also need to have enough funds in your account to cover the cost of your purchase and any fees or commissions charged by your broker. You can then research and select the shares or stocks that you want to buy, and place your order through your broker’s platform. You can buy shares or stocks at the current market price (a market order) or at a specified price (a limit order). Once your order is filled, you will receive a confirmation and your shares or stocks will be held in your account.

Shares
A share is the single smallest denomination of a company's stock. So if you're divvying up stock and referring to specific characteristics, the proper word to use is shares.

Technically speaking, shares represent units of stock.
Common and preferred refer to different classes of a company's stock. They carry different rights and privileges, and trade at different prices. Common shareholders are allowed to vote on company referenda and personnel, for example. Preferred shareholders do not possess voting rights, but on the other hand, they have priority in getting repaid if the company goes bankrupt. Both types of shares may pay dividends, but those in the preferred class are guaranteed to be paid first if a dividend is declared.

Common and preferred are the two main forms of stock shares; however, it is also possible for companies to customize different classes of stock to fit the needs of their investors. The different classes of shares, often designated simply as "A," "B," and so on, are given different voting rights. For example, one class of shares would be held by a select group who are given perhaps five votes per share, while a second class would be issued to the majority of investors who are given just one vote per share.

Stocks
Let's confine ourselves to equities and the equity markets. Investment professionals often use the word stocks as synonymous with companies—publicly-traded companies, of course. They might refer to energy stocks, value stocks, large- or small-cap stocks, food-sector stocks, blue-chip stocks, and so on. In each case, these categories don't refer so much to the stocks themselves as to the corporations that issued them.

Financial pros also refer to common stock and preferred stock, but, actually, these aren't types of stock but types of shares.

So, when people talk about the stock of a company, they are most often talking about their common stock. Common stock represents shares of ownership in a corporation and the type of stock in which most people invest. When people talk about stocks they are usually referring to common stock. In fact, the great majority of stock is issued is in this form. Common shares represent a claim on profits (dividends) and confer voting rights. Investors most often get one vote per share-owned to elect board members who oversee the major decisions made by management. Stockholders thus have the ability to exercise control over corporate policy and management issues compared to preferred shareholders.

For all intents and purposes, yes. Both shares and stocks refer to equity ownership in corporations, and owners can be referred to as either shareholders or stockholders.

Shares vs. Stocks: An Overview
The distinction between stocks and shares in the financial markets is blurry. Generally, in American English, both words are used interchangeably to refer to financial equities, specifically, securities that denote ownership in a public company. (In the good old days of paper transactions, these were called stock certificates). Nowadays, the difference between the two words has more to do with syntax and is derived from the context in which they are used.

Similar Terminology
Of the two, "stocks" is the more general, generic term. It is often used to describe a slice of ownership of one or more companies. In contrast, in common parlance, "shares" has a more specific meaning: It often refers to the ownership of a particular company.

So if someone says they "owns shares," some people's inclination would be to respond, "shares in what company?" Similarly, an investor might tell their broker to buy 100 shares of XYZ Inc. If they said "buy 100 stocks," they'd be referring to a whole panoply of companies—100 different ones, in fact.

That comment "I own shares" might also spark a listener to respond even more generally, "Shares of what? What sort of investment?" It's worth noting that one can own shares of several kinds of financial instruments: mutual funds, exchange-traded funds, limited partnerships, real estate investment trusts, etc. Stocks, on the other hand, exclusively refer to corporate equities, securities traded on a stock exchange.

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