Dealers betting on firms to fail were responsible for the plunge in the price of HBOS shares. Lib Dem Treasury spokesman Vince Cable yesterday called for action to stop stock market abuse. Here, we explain how short-selling works...

What is short selling?

It's a technique to profit from a fall in a company's share price. Most stock market investors buy shares hoping the price goes up.

But you can make profit by "going short". This involves selling a share that you don't even own to buy it back once it has fallen in price, netting a profit in the process.

How can you sell something you don't own?

In a short-sale, the investor is usually a hedge fund or investment bank who expect a company's shares will fall.

The investor borrows the shares (usually from a large pension fund or insurance company) and sells them in the market. Once the shares have fallen, the investor buys them back at the lower price and returns them to the lender.

If it goes to plan, the investor is paying less to buy back the shares than the investor received for selling.

The lender charges a fee for loaning out their shares, but usually the shorter makes a tidy profit.

There's also "naked short-selling" - a form of shorting where the investor doesn't even bother to borrow the shares. This is possible because share deals are often not settled immediately.

The sellers promise to deliver the stock after a short delay - say three days. If short-sellers buy the stock back before they have to make good on the original delivery, no shares need actually change hands.

Why is it controversial?

Fears of market abuse. The clearest victims of such abuse were HBOS, earlier this year. Over just an hour one day in March, shares plunged.

Deliberately placed false rumours swept the market that the bank had financial problems similar to those of Northern Rock. The price recovered later in the day but investors with short positions made a handsome gain.

Planting such rumours is illegal but also very difficult to investigate.

What sort of money is involved?

One hedge fund is thought to have made £1billion betting on the collapse of Northern Rock last year.

What can be done?

Regulators are trying to more closely police short-selling. Pressure has also put on stock lenders. Many pension funds now operate on the basis that they will not loan out any of their shares.