Archive for Short Selling

What is Short Selling?

There are a lot of strategies that people use when they are actively working the stock market. The most common, and safest, strategy is called “long selling.” This is what people normally do. They buy a stock, wait for it to increase in value, and then sell it when the value has increased. It doesn’t take a lot of effort, and people get a decent profit out of their efforts most times.

 

Short Selling

Short selling, however, is much different. It takes advantage of when stocks drop, and then sells back if and when they go back to their normal value. It involves “borrowing” a security or stock from a lender (usually a stockbroker) and then selling it. You then buy the stock back at a lower price than you sold it for, then returning it to the broker and getting your initial investment back from them.

This is incredibly risky for several reasons

1. The stock may not fall. What if you borrow a stock, you sell it, and then some big decision is made in the company and the stock price rises? You’ve now put money out and lost some.

2. The stock may get “called back.” If a lot of people are doing the same thing you are, the company has no stock to actually sell. This is a rare occurrence, but the potential is there.

3. The company may go under. If stocks are falling at the rate you would do this, there’s a risk of the company already struggling enough that bankruptcy is a potential issue. This then would make the money you invested entirely worthless.

So, why do it? Well, some people say that the profits made by falling stocks can be incredibly significant. There are two reasons that you may want to short sell: hedging and speculating.

Hedging: This is where people use a short sell in order to protect a longer investment. They short sell in order to make other stock stabilize or rise. It’s a defensive investment move.

Speculating: This is where a lot of brokers really slam people who short sell. They calculate the risks, take out stock on high risk companies and wait for it to fail. People who speculate thrive on the risk factor, which many people see as a form of gambling instead of actually playing the stock market.

As you can see, there are a lot of things that go into short selling, but people also ask if it s an ethical practice. What do you think?