Naked short selling is a type of short selling in which an investor sells a security that they do not actually own and have not borrowed. This means that they do not have the ability to deliver the security to the buyer at the time of the sale.
Naked short selling can occur when a brokerage firm fails to borrow the necessary shares before selling them or fails to deliver the shares to the buyer after the sale. In some cases, this can lead to a “failure to deliver” situation, where the buyer does not receive the security they purchased, and the seller fails to deliver it.
Naked short selling is illegal in many financial markets because it can be used to manipulate the market or drive down the price of a security. This is because it artificially increases the supply of the security in the market, which can lead to a decrease in the price. Additionally, it can create a risk of market instability and harm the reputation of the market.
To prevent naked short selling, regulators may require investors to locate and borrow shares before selling them short, and impose penalties for failure to deliver. Additionally, they may impose restrictions on short selling during periods of market volatility or in certain types of securities.