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Comment by antonkm | Hacker News Reader

I find the concept of short selling a bit confusing, even though I've Googled. Can someone explain this in an easy to understand way?

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You borrow stock from somebody. You say "I'll give these back to you next month".

You quickly sell these borrowed stock on the market for $100.

1 month passes. The stock goes down.

You buy the same amount of stock, but now for $50.

You return the stock to the person you borrowed it from.

You have profited $50 per stock.

You can now get a nice cold pint and wait for all this to blow over.

3. 1 month passes. The stock goes up.

You HAVE to buy the same amount of stock, but for $150.

You HAVE to return the stock to the person you borrowed it from.

You lost $50 per stock.

That's not quite right. You can hold a short position for as long as you want. There is no contract saying you have to close the transaction in 30 days. In that sense the otherwise excellent analogy provided isn't accurate (which isn't a problem, it's meant to be a simplification).

What does happen if the stock goes up is that your brokerage company will ask you to put up the delta. In other words, if it goes from $100 to $110 you'll be required to deposit the equivalent of $10, the delta, times the number of shares you shorted. If you shorted 1,000 shares you'll have to deposit $10,000 for every $10 of upwards movement in the stock price. If you have long (traditional stock buying) positions in your account your broker might actually sell those automatically to cover this delta.

The other important point is that this is a loan. Which means you will pay interest on the funds, in this hypothetical $100,000. The interest charged can vary. If, for the sake of an example, we assume 5% simple annual this means $5,000 per year or just over $400 per month.

I used to day trade (about 20 years ago) and would use shorting multiple times per day. I am not sure I would consider shorting for long term (> 1 day) positions. As many have said, the potential for loss is great.

If we want to be complete, the alternate situation is that the stock went up. Maybe $1000, maybe $1000000, and now we have lost money. Maybe quite a lot of money, the sky's the limit.

Short selling is not for the faint of heart.

Yeah, short selling is scary: limited upside, unlimited downside. I've been tempted to short some stuff, but have always resisted, because the normal adage of "don't bet anything you can't afford to lose" doesn't apply.

EDIT: This is not the whole truth; see the replies below. You can essentially buy insurance to limit that downside (via a call option), or put up money that you lose if the shorted stock rises above a certain price (via a margin). I am not a lawyer or a financial advisor. I'm just some internet person.

I don't think you can actually have the "unlimited downside" at least as a casual investor.

Nobody trusts you to be able to pay up for the "unlimited downside", so when you short stock, you are required to provide some collateral. For example USD or other stock held in your trading account. When the price of the stock you borrowed rises enough to match your collateral, you need to either provide more, or it gets used to buy the stock and repay the stock debt. You lose your entire collateral but don't get stuck with unlimited debt.

This limits the amount you can lose in total - but actually makes losing some amounts more likely. If you short a stock, but it goes up for a brief while before dropping - then you can still lose your investment at the peak even if you were correct in the long term.

In practice there is never unlimited downside. You should pair your short with a call option at the very least, so your downside is easily limited.

Exactly right. But, if the stock goes up to $150, then you have to buy it back at $150.

The thing about short sales: the most the stock can go down is to zero, but there’s no limit to how high it can rise. So, you have limited upside with unlimited downside.

It’s also a leveraged position, since borrowing the stock is typically free and selling it generates cash. In the example above, you start with $0 and end up with $100 per share in cash and a corresponding $100 per share in debt. In theory, you can short an infinite amount of stock. In practice, you are limited by both margin requirements (debt to equity ratio), and the fact that the market would start moving lower to account for the sudden influx of stock for sale. However, even small moves in price can have a huge influence on the profit or loss of a short sale, since you can turn a small amount of cash into a large short position.

The mechanics are that you loan shares, sell them at the price you think is too high, buy them at the lower price, then hand those cheaper shares back.

The argument for doing so is that humans err in favour of optimism -- ie, that prices will rise. But you can make money on the market moving either way.

Looking on it as a total outsider with limited knowledge, it seems like a fascinating niche in the financial world. But I imagine it is also even more stressful than betting on the price rise, because you're more often going to be outside the pack.

It is a lot more stressful because if you bet on the rise, the most you can lose is what you paid for the stock. Your loss potential with short selling is unbounded.

Kostolany became rich shorting. He wrote the worst of being a short-seller is that you are earning a lot of money while all your friends are losing it. You have to keep a low profile because everyone looks at you as the cause of their loses.

"Short selling" is the process of selling something you don't have, promising to deliver later, on the basis that you expect the price to go down. Then, later, when someone requires you to deliver the items you sold them, you buy them at the current market price and deliver them.

If the price has indeed gone down then you win. Problem is, the price may have gone up, and now you have to buy at a higher price, so you lose. The worst part of this is that the loses are unbounded, since the price rise could be arbitrarily large.

In practice it's not a problem, some you win, some you lose, and you are effectively betting on price market movements.

You can now deal with options. So when you promise to sell someone something in the future at price X, they have the option in the future of taking you up on that. If the price of X has gone down then obviously they will go and buy it directly, but if the price has gone up then they come to you and demand that you supply at the agreed price. In return for this option, they pay you when the deal is strike. Thus you are selling them the option of buying at a price.

Similarly you can sell them the option to sell you something at a price. These options are derivatives from the original concepts of buying and selling at given prices.

There's more, but I'll stop, not least because that's pretty much all I know.

"Short selling" is the process of selling something you don't have, promising to deliver later, on the basis that you expect the price to go down.

Finance 101: You've just described a naked short, which is illegal in the US. You are required to cover the position.

I stand corrected. Perhaps then you can clarify how one can "sell short" if one doesn't initially own any of the product. Someone else has said that you borrow it. But if you then sell it you are selling something you don't own, so that is also surely illegal. And if not, it amounts to the same thing.

So it seems that when you don't initially own any of the product, the only way to "sell short" is to promise to buy it later which is still selling something you don't have.

Unless it really is a case of persuading someone to "lend" it to you, and then selling that, so you are selling something you don't own, and someone else is trusting that you'll return it.

Is that right?

You must have the funds to borrow. Shorting is risky, even more so going naked. Which is why its been illegal since 2008. In practice, professionals use covered call options to manage their risk.

The standard thing everyone understands is you buy a stock S1 at time t1 and sell it later at t2 (let this be S2). The difference (S2 - S1) is your profit. You are hoping the stock price goes up. If it drops you lose money.

Time(t) : ---buy(S1)------------------sell(S2)----->

In short selling, the buy's and sells are reversed, so you are hoping the stock price drops.

Time(t) : ---sell(S1)-----------------buy(S2)------>

Notice that if the stock price drops S2 - S1 is positive. Conversely, if the price rises you lost money.

There are other technical details, but this is conceptually an easy and accurate enough way to think about it.

I understand short selling, but the guy in this story says he's been shorting Tesla for years. In that time, the stock as done nothing but go up, AFAIK. How can he afford to still be shorting? As I understand it, a short position is not something you can hold indefinitely... there's a point in time where you need to provide the shares.

As long as you meet the collateral requirements of whoever is lending you the shares, you can be short for as long as you like really.

Serious investors don’t typically trade in “naked” shorts. They usually cover the downside risk with an “at-the-money” call option (the right to buy shares at the current trading price). If the price goes down by an amount that exceeds the premium of the option, then they make money. If the price goes up, then they only lose the option premium, because they can use the call to re-buy the shares to return.

You can either run this strategy repeatedly, using 3-month options, or buy extremely long-term options and keep it open for as long as the options last.

Like a gambler, the next hand is always going to win.

... also, a short sale doesn’t have a time limit. You can be short as long as you want. However, if prices go up, then the debt in your margin account also goes up, and you might get a “margin call” - either deposit more capital, or close out some leveraged positions.

Margin calls are the nightmare scenarios for short sellers, since they can force you to buy out at the worst possible time.

You just buy a new short position. Also you can have a short position lasting a minute, an hour, a day, a week, a month.

(typically a broker will insist you have sufficient collateral period to indicate you can fulfil the short position).

short and long are both "buy low, sell high"

with long you buy, then sell.

with short you sell, then buy.

https://en.wikipedia.org/wiki/Short_(finance)#Profitable_tra...

Basically you are selling something you don't have.

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