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Short selling is a process that involves borrowing shares from a person, selling them and then buying them back at a lower price, thus realizing a profit.

In this situation, knowing that prices are falling who would be willing to lend shares?

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Are you sure you understand that short selling means selling borrowed shares now and buying them again at a later date (hopefully at a lower price) to return to the lender of the shares that you borrowed? That there is no guarantee that the share price will not increase and you may have to buy the shares at a higher price than you sold them for? That the lender of the shares will charge a fee for loaning you the shares that you borrowed? etc etc etc –  Dilip Sarwate Aug 22 '12 at 15:46
    
ya.. I understand that. –  vivek_jonam Aug 22 '12 at 16:21
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The key here is "Knowing." If we knew that the share price was falling, then the current price would reflect that. I.E. the price would have fallen already, and any sort of primary derivative trading wouldn't occur. The fact of the matter is, we don't know. –  Chris Cudmore Aug 22 '12 at 16:53
    
Think about your last sentence. If prices were known to be falling (and never recovering), why would anyone ever buy the stock again? And if no one will buy the stock, what would the price then be? Zero. But that's not at all how it works. No one ever "knows" anything. –  Chelonian Aug 22 '12 at 18:57
    
The obvious exception is before and after a dividend payment, in which case the drop will be known and accounted for. –  MSalters Aug 30 '12 at 14:37
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3 Answers

You don't actually know that prices of those shares will fall; you are essentially betting that they will fall. Not everyone agrees with you. Someone who believes that the prices will not fall will be willing to loan you shares.

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Your broker will lend you the shares. If it doesn't possess them, it will supposedly borrow it from one or more of its clients, like you, and allow you to short. If it cannot, you wouldn't be allowed to short.

But you are only reading one side of the story. If you don't cover your positions, the broker will forcibly close your positions, whether you have gained or lost, depending on the timeline you might have agreed beforehand. If that isn't the case, then it would ask you to post a specific margin at all times in your account and charge you for carrying over your positions into the next trading day.

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The broker will also charge you interest for borrowing the shares, so they're generally quite happy to lend... with adequate collateral, naturally. –  fennec Aug 22 '12 at 22:06
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Depending on the actual shares, chances are that, for instance, index trackers are obliged to be long in certain shares to e.g. replicate an index. Even if everybody knew the share price will plummet, they are highly likely to lend out the shares if compensated.

Same for every structured product really, think warrants that promise to deliver a certain share after an event, or mutual funds that essentially assemble a portfolio and sell it on in its entirety (or usually as a share thereof) to customers.

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