There’s a lot going on in the stock market this week and both and Reddit in general are inundated with questions about it. This is an opportunity to ask for explanations for concepts related to the stock market. All other questions related to the stock market will be removed and users directed here.
How does buying and selling stocks work?
What is short selling?
What is a short squeeze?
What is stock manipulation?
[What is a hedge fund?](https://www.reddit.com/r/explainlikeimfive/comments/l6ptb7/eli5_what_is_a_hedgefund/)
What other questions about the stock market do you have?
In this thread, top-level comments (direct replies to this topic) are allowed to be questions related to these topics as well as explanations. Remember to follow all other rules, and discussions unrelated to these topics will be removed.
**Please refrain as much as possible from speculating on recent and current events.** By all means, talk about what has happened, but this is not the place to talk about what will happen next, speculate about whether stocks will rise or fall, whether someone broke any particular law, and what the legal ramifications will be. Explanations should be restricted to an objective look at the mechanics behind the stock market.
EDIT: It should go without saying (but we’ll say it anyway) that any trading you do in stocks is at your own risk. **is not the appropriate place to ask for or provide advice on stock buy, selling, or trading.**
In: Economics
Easy way to think about it…
You have 100 shares of company G stock that currently sells at $100. Your friend thinks the price will drop to $50 in one week, so he borrows your 100 shares with the contractual guarantee to return the shares back to you in a week.
He immediately sells those shares for $100. Now neither of you own those shares. But your friend still owes you the shares, so he’ll just buy it back from the market in a week when it drops to $50, return the shares to you and pocket a $5000 profit.
Only, the stock price doesn’t drop, it goes up. To $200. Your friend owes you 100 shares of stock, so he has to buy it from the market for $200. He return the stocks to you and has lost $10000.
Now bump the numbers up. Assume there are 1 million shares of the stock available, so he makes agreements to borrow all 1 million from the owners, yet somehow also manage to borrow about 500,000 shares that simply don’t exist. But since it’s a contract to borrow shares, it doesn’t matter…they’re just paper shares, and he’ll make a fortune when the stock drops. Except the share price doesn’t drop, and he owes people 1.5 million shares, but there are only 1 million shares on the entire market. So not only does he need to buy 1m shares at the new inflated price, he’s also got to somehow but 500,000 shares that are nonexistent. So in order to pay back those borrowed shares, he needs to buy them back from other owners, who are more than happy to sell them back to him at an even higher price than the day before. In short, the attempt to buy back all those shares that he owes but that don’t exist only pushes the price of the stock higher and higher and the losses just keep growing and growing.
If Melvin hadn’t gotten greedy and dumb and bought sell options that exceeded the number of shares in the market, they might have taken a big loss, but now they’re caught in a self-inflicted feedback loop where their losses only keep growing more and more as they try to fill their obligation to pay back all the shares that they owe.
This is why derivatives (assets “derived” from the value of actual assets) can be such dangerous bets…they basically were created to hedge risk, but Wall Street traders tend to just treat it like gambling. And…they not only gamble with the money, they borrow tons of it issuing the investment as collateral…and gamble with that. They think it’s an easy bet, so borrowing isn’t a big deal…unless they miscalculate the risk, which is how it can all blow up in their face. Which is exactly what happened in 2008. They had $100, decided to bet it all on black at roulette…but though the chance of red coming up was <1% so they borrowed another $9,900
to put on black. A dumb bet because they didn’t properly determine the risk of the bet.
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