5 ms·

You borrow stock from somebody. You say "I'll give these back to you next month". You quickly sell these borrowed stock on the market for $100. 1 month passes

by neals 9y ago

You borrow stock from somebody. You say "I'll give these back to you next month". You quickly sell these borrowed stock on the market for $100. 1 month passes. The stock goes down. You buy the same amount of stock, but now for $50. You return the stock to the person you borrowed it from. You have profited $50 per stock. You can now get a nice cold pint and wait for all this to blow over.

otherme32 9y ago
3. 1 month passes. The stock goes up. You HAVE to buy the same amount of stock, but for $150. You HAVE to return the stock to the person you borrowed it from. You lost $50 per stock.
- rebootthesystem 9y ago
  That's not quite right. You can hold a short position for as long as you want. There is no contract saying you have to close the transaction in 30 days. In that sense the otherwise excellent analogy provided isn't accurate (which isn't a problem, it's meant to be a simplification). What does happen if the stock goes up is that your brokerage company will ask you to put up the delta. In other words, if it goes from $100 to $110 you'll be required to deposit the equivalent of $10, the delta, times the number of shares you shorted. If you shorted 1,000 shares you'll have to deposit $10,000 for every $10 of upwards movement in the stock price. If you have long (traditional stock buying) positions in your account your broker might actually sell those automatically to cover this delta. The other important point is that this is a loan. Which means you will pay interest on the funds, in this hypothetical $100,000. The interest charged can vary. If, for the sake of an example, we assume 5% simple annual this means $5,000 per year or just over $400 per month. I used to day trade (about 20 years ago) and would use shorting multiple times per day. I am not sure I would consider shorting for long term (> 1 day) positions. As many have said, the potential for loss is great.
rootusrootus 9y ago
If we want to be complete, the alternate situation is that the stock went up. Maybe $1000, maybe $1000000, and now we have lost money. Maybe quite a lot of money, the sky's the limit. Short selling is not for the faint of heart.
- username223 9y ago
  Yeah, short selling is scary: limited upside, unlimited downside. I've been tempted to short some stuff, but have always resisted, because the normal adage of "don't bet anything you can't afford to lose" doesn't apply. EDIT: This is not the whole truth; see the replies below. You can essentially buy insurance to limit that downside (via a call option), or put up money that you lose if the shorted stock rises above a certain price (via a margin). I am not a lawyer or a financial advisor. I'm just some internet person.
  - ProblemFactory 9y ago
    I don't think you can actually have the "unlimited downside" at least as a casual investor. Nobody trusts you to be able to pay up for the "unlimited downside", so when you short stock, you are required to provide some collateral. For example USD or other stock held in your trading account. When the price of the stock you borrowed rises enough to match your collateral, you need to either provide more, or it gets used to buy the stock and repay the stock debt. You lose your entire collateral but don't get stuck with unlimited debt. This limits the amount you can lose in total - but actually makes losing some amounts more likely. If you short a stock, but it goes up for a brief while before dropping - then you can still lose your investment at the peak even if you were correct in the long term.
  - addicted 9y ago
    In practice there is never unlimited downside. You should pair your short with a call option at the very least, so your downside is easily limited.
URSpider94 9y ago
Exactly right. But, if the stock goes up to $150, then you have to buy it back at $150. The thing about short sales: the most the stock can go down is to zero, but there’s no limit to how high it can rise. So, you have limited upside with unlimited downside. It’s also a leveraged position, since borrowing the stock is typically free and selling it generates cash. In the example above, you start with $0 and end up with $100 per share in cash and a corresponding $100 per share in debt. In theory, you can short an infinite amount of stock. In practice, you are limited by both margin requirements (debt to equity ratio), and the fact that the market would start moving lower to account for the sudden influx of stock for sale. However, even small moves in price can have a huge influence on the profit or loss of a short sale, since you can turn a small amount of cash into a large short position.

by neals 9y ago

otherme32 9y ago

3. 1 month passes. The stock goes up. You HAVE to buy the same amount of stock, but for $150. You HAVE to return the stock to the person you borrowed it from. You lost $50 per stock.

rebootthesystem 9y ago
That's not quite right. You can hold a short position for as long as you want. There is no contract saying you have to close the transaction in 30 days. In that sense the otherwise excellent analogy provided isn't accurate (which isn't a problem, it's meant to be a simplification). What does happen if the stock goes up is that your brokerage company will ask you to put up the delta. In other words, if it goes from $100 to $110 you'll be required to deposit the equivalent of $10, the delta, times the number of shares you shorted. If you shorted 1,000 shares you'll have to deposit $10,000 for every $10 of upwards movement in the stock price. If you have long (traditional stock buying) positions in your account your broker might actually sell those automatically to cover this delta. The other important point is that this is a loan. Which means you will pay interest on the funds, in this hypothetical $100,000. The interest charged can vary. If, for the sake of an example, we assume 5% simple annual this means $5,000 per year or just over $400 per month. I used to day trade (about 20 years ago) and would use shorting multiple times per day. I am not sure I would consider shorting for long term (> 1 day) positions. As many have said, the potential for loss is great.

rootusrootus 9y ago

If we want to be complete, the alternate situation is that the stock went up. Maybe $1000, maybe $1000000, and now we have lost money. Maybe quite a lot of money, the sky's the limit. Short selling is not for the faint of heart.

username223 9y ago
Yeah, short selling is scary: limited upside, unlimited downside. I've been tempted to short some stuff, but have always resisted, because the normal adage of "don't bet anything you can't afford to lose" doesn't apply. EDIT: This is not the whole truth; see the replies below. You can essentially buy insurance to limit that downside (via a call option), or put up money that you lose if the shorted stock rises above a certain price (via a margin). I am not a lawyer or a financial advisor. I'm just some internet person.
- ProblemFactory 9y ago
  I don't think you can actually have the "unlimited downside" at least as a casual investor. Nobody trusts you to be able to pay up for the "unlimited downside", so when you short stock, you are required to provide some collateral. For example USD or other stock held in your trading account. When the price of the stock you borrowed rises enough to match your collateral, you need to either provide more, or it gets used to buy the stock and repay the stock debt. You lose your entire collateral but don't get stuck with unlimited debt. This limits the amount you can lose in total - but actually makes losing some amounts more likely. If you short a stock, but it goes up for a brief while before dropping - then you can still lose your investment at the peak even if you were correct in the long term.
- addicted 9y ago
  In practice there is never unlimited downside. You should pair your short with a call option at the very least, so your downside is easily limited.

URSpider94 9y ago

Exactly right. But, if the stock goes up to $150, then you have to buy it back at $150. The thing about short sales: the most the stock can go down is to zero, but there’s no limit to how high it can rise. So, you have limited upside with unlimited downside. It’s also a leveraged position, since borrowing the stock is typically free and selling it generates cash. In the example above, you start with $0 and end up with $100 per share in cash and a corresponding $100 per share in debt. In theory, you can short an infinite amount of stock. In practice, you are limited by both margin requirements (debt to equity ratio), and the fact that the market would start moving lower to account for the sudden influx of stock for sale. However, even small moves in price can have a huge influence on the profit or loss of a short sale, since you can turn a small amount of cash into a large short position.