2026 What Does "Sell Short" mean?

Sunday, September 21, 2008

This is a very simple explanation.
- You have 10 shares of ABC, and it's selling for $100 a share right now.
- ABC looks to me like it might be overvalued, and the stock might be on the verge of a slide.
- I go to you and ask you to "lend" me your 10 shares, and I'll pay you Z dollars "rent" for them.
- I sell those shares, and pocket $1,000 dollars, minus the Z dollars "rent" I pay you.
- The stock drops. Now it's $20 a share.
- I buy 10 shares at $20 each, $200 worth, and I give them to you.
- I just made $800 minus Z dollars profit.

Of course there are a lot more details, but that's the basic theory. I am a short seller, and you are a fool. That's pretty much it, except that it's done on the level of hundreds of thousands of shares at a time, not 10.

I can get hurt doing it if the stock goes up instead of down and you demand your stock back, or the term of our contract ends, while it's high, and I have to buy stock to replace yours at a higher price. Piper has told me horror stories about people who were "caught short".

If the stock doesn't go down, you will get Z dollars profit and you still own the stock. It's like renting out your second home or something.

However, I still have trouble understanding why ANYONE would "rent out" the stock to a short seller. That would be like renting real estate to college students. It ISN'T likely to come back in the same condition.

The market is stacked in favor of short sellers, because if several of them sell huge blocks of stock all at once, that almost guarantees the price will fall. They can make their prediction come true simply by predicting it. There's gotta be something wrong with that. And that's why it's banned right now - to prevent an avalanche.

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UPDATE: 9/22/08 I talked with Piper today. The above description is the general theory of what happens, but it's not exactly how it happens. There's no "you", and no real "in the hand" stock. And if I told how it really worked, nobody'd believe me.
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