- In a broad sense, OTC refers to any stock not sold on an exchange --- a physical building with trading pits and computer monitors like the New York Stock Exchange. The term has evolved with the advent of computers. The NASDAQ, commonly thought of as a stock exchange, is actually an OTC market where highly traded stocks are swapped via a computer system. There are also still old, low-volume stocks traded through "bulletin boards," which are electronic lists of sellers where buyers can find smaller, less frequently traded companies.
- In a short sale, a trader borrows stock from her broker, which is commonly referred to as trading on margin. She sells the broker's stock at a particular price and keeps the proceeds. When the stock price drops, she buys shares back to repay the broker. The net of the sale and buy are her profits. Short sales count on the price of a stock going down, so traders have the potential for profit even in tough market conditions.
- Short selling is limited by share availability. "Naked" short sales --- where the trader doesn't even bother to borrow from a broker --- are generally illegal in the U.S., and do not follow the policies of most brokerage firms. To short, you must be able to borrow the shares. In general, NASDAQ stocks exist in enough volume to borrow, but smaller OTC stocks may not.
- Even if a particular stock is available for borrowing, short sellers must always consider stock liquidity when deciding what to trade. Short sales rely upon the trader's ability to buy back the shares at a low price. In less active markets, this ability may be limited simply because the stock is not available. This increases the risk associated with short selling and may result in losses rather than profit.
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