Using an example lightly inspired by my friend's real-life situation:
Let's say my friend, John (representing a stockowner) owns a Ducati (representing a stock), and John doesn't know that the Ducati is about to need a costly engine rebuild. But I know this. Even though I don't own the bike, I can profit from this shift in the Ducati's value.
To do this (short sell), I borrow the Ducati from John for a week and sell it to someone (the general market), let's call him Bob, the very next day, at market value. A couple of days later, the Ducati stopped working because it needed the engine repair service. So Bob, who bought the motorcycle without knowing about the upcoming service, comes back to me and wants to get rid of it. So I offered him half of what he paid me for the bike. I then pocket the difference and return the Ducati to John, who let me borrow it.
Disregarding the morals of this example or the costs to repair the Ducati, this is short selling in a nutshell. However, the risk comes if the Ducati becomes worth more than what I sold it to Bob for, because I still have to return the bike to John by the end of the week.
In this second example of short selling (now, explaining how you can lose money), I've already been allowed to borrow the Ducati for next week. And just sold it to Bob, but unbeknownst to me, Bob has all the tools and experience to do this engine work on his own. For this reason, the Ducati increases in value and Bob doesn't want to sell it. So at the end of the week, I ask Bob if he's willing to sell it, and he hesitantly says he's willing to hear offers. I then talk to him and agree to buy it back for a couple grand more than what bob originally paid me for the Ducati. I take a loss. But by the end of that week, John still got his Ducati back.
