I just cannot, for the life of me, understand how you make a profit by it.
In: Economics
The concept involves borrowing a security, and selling it
At that point you need to repay the lender a number of shares. If the price of those shares decreases, you can buy them back for less than you sold them for, turning a gross profit on the trade (before margin interest is subtracted).
In short selling you “borrow” stock from someone for a fee. Let’s say it’s $5. So you pay them $5, they lend you the stock for a week. Let’s agree the stock is worth $100.
You are convinced the stock is about to tank, you immediately sell it for $100.
The next day the stock does indeed tank and is now worth $50. You rebuy the stock for $50.
At the end of the week you give your friend the stock back.
You made $100 from the stock sale, you spent $5 (the borrowing fee) + $50 (buying the stock back) = $55
So $100 – $55 = $45. You earned $45 profit from “shorting” the stock.
Obviously this would have been a great deal for you. Imagine what would happen if the stock didn’t crash and instead went up to $200 per share. Oops.
You give your friend 10 usd to borrow his bike and you agree to give it back in a month.
You then show “your” new bike to your friends and one of them offers to buy it for 100 usd. You know black Friday is coming before you need to return the bike and you know you can get it cheaper there so you sell it. Black Friday comes around and you buy the bike for 80 dollars and then return it to your friend. Congratulations, you made 10 dollars shorting.
Aside from consent issues in the example, it’s the same for stocks. You borrow someone else’s stock, you sell those stocks and hope they will be valued less when it’s time to return them because you need to buy same number of stocks back.
[This answer is from here.](https://www.reddit.com/r/explainlikeimfive/comments/17efm0e/eli5_the_mechanics_and_concept_of_shorting_stocks/)
To make a profit the normal way you buy a stock now and sell it later at a higher price.
Buy AAPL 10/16/24 for $100 and sell it on 11/12/24 for $120.
To make a profit via short selling you do it in reverse. Sell, then buy. But you don’t have the stock at the start. You have to borrow someone else’s share (and pay interest because it’s a loan), sell it, then plan on buying it back in the future.
Borrow and sell AAPL on 11/12/24 for $120 and buy it back at $100 on 12/17/24.
Super simplified and ignoring regulations and stuff, you basically borrow a stock from somebody for a set amount of time. You then sell that stock. At the end of the set time, you have to buy the stock back and give it back to the person you borrowed it from.
If the price has gone down in the meantime, you get to keep the difference. If the price goes up, you lose the difference.
Short selling is selling a share of a stock you don’t currently own with the promise that you’re going to buy it back later. Typically with stocks, you buy them now, hope the price goes up, and then you sell it in the future when it’s worth more money. With short selling, you borrow shares from someone who actually owns them, they charge you a small amount of interest for every day you borrow them, and you sell them immediately, getting the value of the shares at that moment in time. Now you’re on the hook to return those shares you borrowed. Hopefully, in the future those shares are worth less than you paid for them, and when you buy the same number of shares back to return to the person you borrowed them from, you get to pocket the difference.
The reason this is so risky though is that buying shares normally, the absolute worst you can ever do is lose 100% of your money invested. With short selling, there’s no actual limit to how high the price can go, meaning there’s no limit to how much money you can lose. You can borrow $1000 worth of stocks, sell them, make your $1000 and then the share price goes through the roof and you’re forced to spend $50000 to return the shares back to who you borrowed them from. This is essentially what happened with Gamestop back in 2021, and it’s a pretty quick way to bankrupt your hedge fund if you make a bad bet on a short sell
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.
Pretend bacon and cheese sandwiches (I’m hungry) are selling for $50 each right now. I think they’re going to go down in price tomorrow. I borrow a sandwich from a friend and promise to pay them back a sandwich later. I sell that sandwich to you for $50. The next day, we find out I was right, and bacon and cheese sandwiches are selling for $10 each. I buy one for $10, and give it back to the friend I borrowed it from.
I sold a sandwich for $50, and bought one for $10. My net profit is $40.
The downside is if the price goes up, I will lose money. This is what makes short selling risky, because there’s almost no limit to how high it can go, but it can only go down to $0.
It’s still just “buy low, sell high”, except maybe it’s better to say it as “sell high, buy low”.
Do you mean with stocks? When you’re shorting a stock you’re betting that the stock price will drop. You ‘borrow’ the shares at the current price (basically a contract that you’ll officially purchase them at a future date) sell them immediately at face value to someone else, and then hope the share price drops by the time the contract term comes due.
Say Apple stock is $230/share and you think that in 2 weeks it’s going to be lower. You borrow 10 shares for $2,300 and sell them for $2,300 to someone else. You have two weeks to pay for those 10 shares that you borrowed (per the terms of the contract you bought). If Apple dips to $200/share in 2 weeks you pocket the difference, so you end up paying $2,000 for the shares you sold for $2,300.
The tricky part is if the stock goes up you can be caught losing money. If in two weeks Apple stock is $300/share then you have to pay $3,000 for the 10 shares you already sold for $2,300, so you lose $700.
The thing that made it easier for me to understand short-selling was this: when you borrow shares of stock from some entity, you don’t owe them dollars…you owe them shares. Doesn’t matter if the price of the shares has gone up or down in the meantime. You borrowed shares; you owe shares.
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