When you buy a stock, you pay money and someone else gives you a stock. Once you have it, you can hold it for as long as you want. Its value can go up or down. When you sell, you get money, which might be less or more than what you paid. If the value goes to zero, you can no longer sell and you will never get any money.
When you short a stock, you are basically selling a stock you don't have. Thus you get money and owe someone else a stock (in practice what happens is someone else unknowingly gives you a stock for free and then you sell it, and they get an IOU for a share of the stock later; but let's not worry too much about the mechanics). Once you have this IOU, you can hold on. The value of the liability associated with the IOU can go up or down. If it goes down, then when you discharge that liability by buying the share you owe, you will pay less than you were paid for the short, thus making a profit. If it goes up, then you will pay more and thus lose money. One risk with a short is that your liability is unbounded. In a traditional stock purchase, the worst that can happen is that you lose the money you put in. In a short sale, you can lose many multiples of the money you put in if the stock does very well. Under a few circumstances, the IOU can be called, forcing you to prove that you have the money to buy a share; for instance, if you were to short $1,000,000 in shares and the share price triples, you owe $3,000,000.
To summarize: when you buy a stock, it's because you think it will be worth more later (again, let's set aside dividends and other things). When you short a stock, it's because you think it will be worth less later.
The reason shorting is permitted is because in general, there is a belief (mistaken or not), that additional liquidity -- more trading -- benefits everyone involved in a market by reducing the spread between prices for buying and selling; additionally, shorting makes it possible to hedge your exposure to a sector (i.e. to trade off some upside in a sector with some corresponding downside and vice versa).
Thanks for the explanation! What happens when someone shorts a stock and then the company goes under? In this case of SVB, you short a stock, company gets taken by FDIC, trading is halted and I'm assuming the company will be sold/dissolved? So what happens with the shorts?
> (in practice what happens is someone else unknowingly gives you a stock for free and then you sell it, and they get an IOU for a share of the stock later; but let's not worry too much about the mechanics)
That's a mis-characterisation. What makes you think the counterparty lends you the stock unknowingly?
> The reason shorting is permitted is because [...]
You forgot the most important reasons:
First, why forbid voluntary transactions between people? Stock lending is an activity between consenting adults.
Second, short selling is a way to finance muckracking and investigations. Short sellers are the only people with an incentive to burst manias. They are an important mechanism for the market to regulate itself.
A simple explanation is that you borrow a certain number of stocks, sell it, and re-buy at some point in the future (at a lower price hopefully) to return the number of stocks you borrowed.
Imagine you think widgets that are worth $1 today are going to be worth $0.50 tomorrow. You say to me, "Hey jpdb, can I borrow 100 widgets and give them back to you tomorrow?" I say sure and you turn around and sell those widgets. Tomorrow, we meet up and you take your $100 and buy 100 widgets for the new price of $0.50 each. You return the 100 widgets you borrowed and you now have $50 in your pocket. In this example you have "shorted" widgets.
You borrow some stock. You sell it. You wait a while. You buy the same stock again. You give it back.
It's very similar to when you take a loan:
You borrow some money. You 'sell' the money for goods and services. You wait a while. You acquire some money again. You give the money back.
In both cases, you pay some interest while the loan is outstanding. (In both cases, you typically pay the interest with money. Instead of with small pieces of stock.)
You literally borrow someone else’s stock and sell it. You now owe them the stock which effectively leaves you with a negative position. Eventually you have give them the stock back which will require you to buy it. If the price has gone down you make money.
A short seller borrows shares from a shareholder - a bank, institutional investment group, or an individual who makes them available in return for interest payments - and sells them on the market at the current price. They hope to return the shares by buying them back at a lower price later and pocketing the difference.
Short selling on its own is trading on the hope that a stock goes down by borrowing shares from someone who owns them and immediately selling them. Your broker will match you to an owner who is willing to lend the shares if there are any available. To exit the trade, you buy back the shares you borrowed.
Your profit from this trade is the stock's price when you entered the trade minus the price when you buy it back (i.e. you want to sell high and then buy low), less any financing costs from borrowing the shares.
Shoring is, financially-speaking, quite complicated and can be very opaque. It's also fundamentally different than longing (not merely the "opposite").
notafraudster|3 years ago
When you short a stock, you are basically selling a stock you don't have. Thus you get money and owe someone else a stock (in practice what happens is someone else unknowingly gives you a stock for free and then you sell it, and they get an IOU for a share of the stock later; but let's not worry too much about the mechanics). Once you have this IOU, you can hold on. The value of the liability associated with the IOU can go up or down. If it goes down, then when you discharge that liability by buying the share you owe, you will pay less than you were paid for the short, thus making a profit. If it goes up, then you will pay more and thus lose money. One risk with a short is that your liability is unbounded. In a traditional stock purchase, the worst that can happen is that you lose the money you put in. In a short sale, you can lose many multiples of the money you put in if the stock does very well. Under a few circumstances, the IOU can be called, forcing you to prove that you have the money to buy a share; for instance, if you were to short $1,000,000 in shares and the share price triples, you owe $3,000,000.
To summarize: when you buy a stock, it's because you think it will be worth more later (again, let's set aside dividends and other things). When you short a stock, it's because you think it will be worth less later.
The reason shorting is permitted is because in general, there is a belief (mistaken or not), that additional liquidity -- more trading -- benefits everyone involved in a market by reducing the spread between prices for buying and selling; additionally, shorting makes it possible to hedge your exposure to a sector (i.e. to trade off some upside in a sector with some corresponding downside and vice versa).
kklisura|3 years ago
Edit: Answered already by someone in other thread https://news.ycombinator.com/item?id=35107107
eru|3 years ago
That's a mis-characterisation. What makes you think the counterparty lends you the stock unknowingly?
> The reason shorting is permitted is because [...]
You forgot the most important reasons:
First, why forbid voluntary transactions between people? Stock lending is an activity between consenting adults.
Second, short selling is a way to finance muckracking and investigations. Short sellers are the only people with an incentive to burst manias. They are an important mechanism for the market to regulate itself.
eadmund|3 years ago
Lends it for a fee, right?
junon|3 years ago
jpdb|3 years ago
Imagine you think widgets that are worth $1 today are going to be worth $0.50 tomorrow. You say to me, "Hey jpdb, can I borrow 100 widgets and give them back to you tomorrow?" I say sure and you turn around and sell those widgets. Tomorrow, we meet up and you take your $100 and buy 100 widgets for the new price of $0.50 each. You return the 100 widgets you borrowed and you now have $50 in your pocket. In this example you have "shorted" widgets.
eru|3 years ago
It's very similar to when you take a loan:
You borrow some money. You 'sell' the money for goods and services. You wait a while. You acquire some money again. You give the money back.
In both cases, you pay some interest while the loan is outstanding. (In both cases, you typically pay the interest with money. Instead of with small pieces of stock.)
As always Wikipedia is worth a look: https://en.wikipedia.org/wiki/Short_(finance)
JackFr|3 years ago
diggum|3 years ago
settrans|3 years ago
Your profit from this trade is the stock's price when you entered the trade minus the price when you buy it back (i.e. you want to sell high and then buy low), less any financing costs from borrowing the shares.
dvt|3 years ago
Shoring is, financially-speaking, quite complicated and can be very opaque. It's also fundamentally different than longing (not merely the "opposite").