I just cannot, for the life of me, understand how you make a profit by it.
In: Economics
This is a little simplified, especially in the motive of the counterparty, but it captures pretty well the fundamental avenue to profit:
Your friend wants a box of cookies from store but is too lazy to get it himself. You look up the price of the cookies online, and it’s $5. You make a deal with your friend: If he gives you $5 now, you will buy him a box of cookies the next time you go to the store. If the price isn’t $5 at that time, that’s your problem, not his. What you’re hoping is that the next time you go to the store, the cookies will be on sale, in which case you can pocket the difference between $5 and the sale price. On the other hand, it’s also possible that the cookies will go up in price, in which case you’re responsible for covering the increase.
That’s the basic mechanism of a short and why people who take out a short profit when the price of an asset falls. Notably, the biggest profit you can make from this deal is $5, if the cookies somehow become free. However, the biggest loss is theoretically infinite – the cookies could go up *any* amount in price, and you’d still be obligated to buy them.
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