I just cannot, for the life of me, understand how you make a profit by it.
In: Economics
It’s a form of gambling, really. You’re betting that a stock will sink in price. You do it by promising to sell someone that stock to someone in the future for a price that’s somewhere above what you think it will be when that future date arrives. Let’s look at an example:
* Stock S is trading at $100/share.
* Trader A thinks that by next week, Stock S will be trading at $50/share.
* Trader A offers to sell Stock S to Trader B at $75/share next week. Trader B accepts because he does not believe Stock S will tank and therefore that $75/share will be a fantastic price when the time comes.
* Outcome 1 – the short works: Stock S tanks to $50/share as Trader A expected. Trader A buys some at that price and then sells it to Trader B for the promised $75/share, turning a quick $25/share profit.
* Outcome 2 – the short doesn’t work: Stock S does not tank and remains at $100/share. Trader A is forced to buy it at $100/share and sell it to Trader B for $75/share, thereby losing $25/share.
* Note: Profit from doing this can go as high as the stock can tank (i.e. current price above zero, $100/share in this example is the max profit). Losses are potentially infinite because Stock S could rise in price to any theoretical number. i.e. if Stock S suddenly rises to $1000/share, then Trader A would lose $925/share.
Latest Answers