Shorting - Can Someone Explain

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Boxtrap
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Shorting - Can Someone Explain

Post by Boxtrap » Fri May 04, 2018 12:38 pm

Can someone please explain short selling to me? I know enough about investing to be pretty conversant, but I can't seem to wrap my head around short selling. I understand that you're betting on a stock or a sector to go DOWN instead of up. But that's about where my understanding stops. I'd love to finally not feel so uneducated about this particular area. Can anyone provide me with an explanation of this that will demystify it for me? Or some recommended reading?

Many thanks and Happy Friday!

sport
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Re: Shorting - Can Someone Explain

Post by sport » Fri May 04, 2018 12:40 pm

I am not an expert in this. However, shorting involves selling borrowed shares, and then buying them back at some future time when the price is (hopefully) lower and replacing the borrowed shares.

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Pajamas
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Re: Shorting - Can Someone Explain

Post by Pajamas » Fri May 04, 2018 12:43 pm

What sport said. It is simply reversing the usual order of buying and selling. You sell now and buy later.

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dm200
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Re: Shorting - Can Someone Explain

Post by dm200 » Fri May 04, 2018 12:44 pm

Boxtrap wrote:
Fri May 04, 2018 12:38 pm
Can someone please explain short selling to me? I know enough about investing to be pretty conversant, but I can't seem to wrap my head around short selling. I understand that you're betting on a stock or a sector to go DOWN instead of up. But that's about where my understanding stops. I'd love to finally not feel so uneducated about this particular area. Can anyone provide me with an explanation of this that will demystify it for me? Or some recommended reading?
Many thanks and Happy Friday!
When you sell "short", you (through your broker) sell share of a stock that you do not own. Say, for example, that shares of XYZ are trading at $10 per share and you short XYZ 100 shares. You "have", then, $10,000 from the sale. The share you sold were borrowed from another brokerage customer and will have to be replaced. Now, XYZ drops to $5 per share and you buy it back - spending $5,000. You made $5,000. If the stock goes up, though, you will have to buy it back and take a (potentially big) loss.

There are a lot more aspects and details - but this is the basic idea.

lack_ey
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Re: Shorting - Can Someone Explain

Post by lack_ey » Fri May 04, 2018 12:56 pm

Note that in the above, it costs money to borrow stocks (of course nobody is going to give them to you for free). Stocks in high demand for shorting tend to be more expensive to borrow, sometimes effectively well into double digits percentages a year. Also, the short seller needs to pay the original owner the dividends that owners of the stock would receive.

These functions are generally handled by a brokerage and transparent to the investor, but it's an important aspect of the arrangement to understand.

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verbose
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Re: Shorting - Can Someone Explain

Post by verbose » Fri May 04, 2018 1:00 pm

What I know about shorting is from writing brokerage software. I’ve never done it.

You must have a margin account. You might also need a special authorization to do short sales in that margin account.

The broker arranges for you to borrow the shares you short, but that’s not free. As long as the short position is open, you will owe fees on the borrowed shares, in addition to margin interest.

Short positions should not be held for long. The fees and margin interest add up, plus the stock price might move in the wrong direction (up). Traders who hold short positions should be watching the market when it’s open to take quick action. It’s not very different from day trading.

If the brokerage feels your short position leaves you overly exposed, or you trigger one of the algorithms, you could get a margin call, fed call, maintenance call, etc. The brokerage can and will close your short position for you if you don’t take quick action after this occurs. This is never a profitable outcome for you, but it stops the bleeding.

That said, short-selling is not a tool in the Boglehead toolbox. I can’t think of any scenario in which it would conform to the investing principles we espouse here.

Jags4186
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Re: Shorting - Can Someone Explain

Post by Jags4186 » Fri May 04, 2018 1:05 pm

A safer way of betting a stock is going to drop is to buy put options. They will cost more money upfront but your loss is limited to the option premium. With short selling you could be completely wiped out if a stock spikes.

deltaneutral83
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Re: Shorting - Can Someone Explain

Post by deltaneutral83 » Fri May 04, 2018 1:19 pm

I would assume short positions are around a very specific (i.e. shorter) time frame as the margin interest is astronomical. Buying puts seems like the safer way to play stock declines if you're into the single stock gamble.

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Pajamas
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Re: Shorting - Can Someone Explain

Post by Pajamas » Fri May 04, 2018 1:21 pm

Margin interest rates can be less than mortgage interest rates if you shop around.

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Re: Shorting - Can Someone Explain

Post by Boglegrappler » Fri May 04, 2018 1:23 pm

You've got the basics from the above posts. You set up a margin account, get approved for short-selling, and then you call your broker and say sell short 300 shares Jones Co at (the market, or a given price limit). There is a "hard to borrow" list at every firm and your broker may tell you he can't borrow that stock....so you can't sell it short. After you've sold, you wait for the stock to fall, and then you buy "to cover", which returns the borrowed stock to the original lender (a firm).

I don't recommend it. The professional short sellers around are extremely smart guys, and even they have their comeuppances when the rest of the world doesn't see it their way. Plus, heavily shorted stocks have a "short squeeze" from time to time, where sharp traders will attempt to run the stock higher and panic the short sellers into covering at the high price to stop their losses.

I think that to be a successful short seller, you need actual inside information, which is illegal to trade on anyway.

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dm200
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Re: Shorting - Can Someone Explain

Post by dm200 » Fri May 04, 2018 2:18 pm

Going further - if the price of the shorted stock goes up too much, you have to provide more assets for margin. If you cannot, this is a margin call - and the stock is purchased - driving up the price more. If lots of folks have shorted the stock - and they get such calls - it can be a big mess - as the stock goes up and more and more is purchased.

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greg24
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Re: Shorting - Can Someone Explain

Post by greg24 » Fri May 04, 2018 2:24 pm

Explain short-selling like I'm five:

http://blog.wallstreetsurvivor.com/2014 ... e-im-five/

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dm200
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Re: Shorting - Can Someone Explain

Post by dm200 » Fri May 04, 2018 2:28 pm

And if you really want to get into the weeds - consider short selling commodities - such as grain or pork bellies. You sell things you do not have and "promise" to buy them back before you have to deliver the goods. ;)

alex_686
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Re: Shorting - Can Someone Explain

Post by alex_686 » Fri May 04, 2018 2:35 pm

dm200 wrote:
Fri May 04, 2018 2:28 pm
And if you really want to get into the weeds - consider short selling commodities - such as grain or pork bellies. You sell things you do not have and "promise" to buy them back before you have to deliver the goods. ;)
Futures is a entirely different ball of wax, at least from a mechanical side.

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Re: Shorting - Can Someone Explain

Post by alex_686 » Fri May 04, 2018 2:39 pm

deltaneutral83 wrote:
Fri May 04, 2018 1:19 pm
I would assume short positions are around a very specific (i.e. shorter) time frame as the margin interest is astronomical. Buying puts seems like the safer way to play stock declines if you're into the single stock gamble.
You use Margin for longer time frames. For shorter time frames you use options. Options have a fixed expiration date.

The actually cost of using options is pretty low. Yeah, you may need to pay "rent" on your short stocks, however you do get a big wad of cash up front. Invest in Treasuries and you generate more than sufficient cash flow to cover the rent. And you can keep this short going year after year until the market eventually moves your way.

FYI, I used to work on the margin desk during the dot.com and 9/11 market crash. I don't recommend going short. The market can stay irrational longer than you can stay liquid.

Silk McCue
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Re: Shorting - Can Someone Explain

Post by Silk McCue » Fri May 04, 2018 2:48 pm

A friend of mine (really - it’s not me) on the advice of a hopped up broker shorted a stock that was a sure thing to go bust. I think they were in for $50k. The company was strategically acquired unexpectedly and my friend told me it cost him $300k by the time it was all said and done.

Cheers

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JoMoney
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Re: Shorting - Can Someone Explain

Post by JoMoney » Fri May 04, 2018 2:51 pm

What others have said, but I'll add that "naked short selling" is illegal, even though they would eventually have to 'cover' (buy the shares they sold) it could create an unstable situation if short-sellers could sell more shares than actually exist... so they have to borrow the shares first from a broker willing to lend them. When the broker lends shares they get collateral to ensure they're covered if the borrower doesn't return them, they also get paid an amount (depending how difficult the shares are to borrow) and this can help boost returns for mutual funds that have a lending program and give the money to the fund.

There used to be something called the "uptick rule", but was removed, and later a limited modified version was put in place. It's a bit controversial, but it required that in order for someone to short sell a stock there need to be an up-tick in the price, without the rule it's theorized that short-sellers can flood an already depressed market that doesn't have buyers artificially suppressing prices below what a willing buyer/seller would agree to in a more orderly market.
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Re: Shorting - Can Someone Explain

Post by Fallible » Fri May 04, 2018 5:38 pm

Boxtrap wrote:
Fri May 04, 2018 12:38 pm
Can someone please explain short selling to me? ... Can anyone provide me with an explanation of this that will demystify it for me? Or some recommended reading? ...
You have some good explanations posted here. As for reading about shorting at its most lucrative, try two great books, The Big Short by Michael Lewis, and The Greatest Trade Ever, by Gregory Zuckerman.
Bogleheads® wiki | Investing Advice Inspired by Jack Bogle

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Re: Shorting - Can Someone Explain

Post by hicabob » Fri May 04, 2018 5:42 pm

Asensio.com is Manuel Asensio's website in which he details his trades and critiques of the companies. He's been a very successful short up until his last one, oled, which he is short at 37 and it's now 102. The website is interesting and I bet you will know some of the companies he made $$ on.

Boxtrap
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Re: Shorting - Can Someone Explain

Post by Boxtrap » Fri May 04, 2018 6:00 pm

Thanks all! Very helpful!

Shorting sounds like a great way to either make a ton or LOSE a ton ;)

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David Jay
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Re: Shorting - Can Someone Explain

Post by David Jay » Fri May 04, 2018 6:13 pm

Boxtrap wrote:
Fri May 04, 2018 6:00 pm
Thanks all! Very helpful!

Shorting sounds like a great way to either make a ton or LOSE a ton ;)
You are betting against the trend.

It only works if you have inside information (information that the market does not know) leading you to believe that a company is in trouble. If you have inside information and short a stock, you go to jail.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Shorting - Can Someone Explain

Post by KSActuary » Sat May 05, 2018 11:07 am

David Jay wrote:
Fri May 04, 2018 6:13 pm
Boxtrap wrote:
Fri May 04, 2018 6:00 pm
Thanks all! Very helpful!

Shorting sounds like a great way to either make a ton or LOSE a ton ;)
You are betting against the trend.

It only works if you have inside information (information that the market does not know) leading you to believe that a company is in trouble. If you have inside information and short a stock, you go to jail.
This statement is so far afield that it should be removed. Many well-known investors have made significant sums of money shorting investable assets without "going to jail". Kyle Bass comes to mind. Another would be Paul Singer (Elliott Management).

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dm200
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Re: Shorting - Can Someone Explain

Post by dm200 » Sat May 05, 2018 2:04 pm

I cannot give the pros and cons - but you can also sell short a stock that you continue to own. Doing that is much lower risk. Never done this - but perhaps others can give more details.

ThrustVectoring
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Re: Shorting - Can Someone Explain

Post by ThrustVectoring » Sat May 05, 2018 11:21 pm

dm200 wrote:
Sat May 05, 2018 2:04 pm
I cannot give the pros and cons - but you can also sell short a stock that you continue to own. Doing that is much lower risk. Never done this - but perhaps others can give more details.
It's called "shorting against the box" and was primarily useful as a tax avoidance strategy prior to 1997. It's pretty much pointless to do now.

Anyhow, one classic way active funds use shorting is with a long/short fund. The basic principle is to put 130% of the fund value in long positions and another 30% in short ones. This leaves you with a market beta around 1 - if there's a crash, your 30% short position gains in value to offset the levered losses long. And ideally you'd be able to pick underperforming stocks to short as well as outperforming stocks to hold long.

That's the theory, at least. You're better off just buying a broad-market index fund.

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Re: Shorting - Can Someone Explain

Post by RadAudit » Sun May 06, 2018 9:54 am

One of the things I remember about short selling is an old (really old and really bad) observation - He that sells what isn't hiz'n, buys it back or goes to pris'n. :)

Sort of stuck with me.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The Calvary isn't coming, kids. You are on your own.

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Re: Shorting - Can Someone Explain

Post by sawyer_sully » Sun May 06, 2018 10:26 am

I had a similar struggle with understanding the concept of shorting, it is not necessarily the easiest thing in the world to understand.

Shorting, in its simplest form, is betting that the value of a stock will decrease.

The logistics of a short sale is where it gets a little more complicated. In a short sale, a stock is borrowed, and then immediately sold. At a later time, this stock is bought back, and returned to the original owner. If the short was done correctly, the stock would have been bought back at a lower price, and the difference between the original price, and what it was bought back at, would be pocketed.

This explanation is by no means all-encompassing, it is just shorting from how I understand it.

https://www.investopedia.com/terms/s/shortselling.asp


Another way to short something would be through put options.

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Re: Shorting - Can Someone Explain

Post by lack_ey » Sun May 06, 2018 10:31 am

Boxtrap wrote:
Fri May 04, 2018 6:00 pm
Thanks all! Very helpful!

Shorting sounds like a great way to either make a ton or LOSE a ton ;)
Wait, how so? Would you say the same about being long the asset? Payout is basically the same but inverse then minus some costs. It's pretty much as volatile as owning the asset, not something much riskier or prone to more gains or losses.

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Re: Shorting - Can Someone Explain

Post by Boglegrappler » Sun May 06, 2018 10:48 am

The issue is that a passive indexed long approach has an expected return of x ( you choose your prediction, but some say as high as 6-8%, or even more).

The same short sale of every stock in an index necessarily has the obverse result, which is a negative return of the same amount.

What becomes clear is that shorting is not a passive strategy. You are "swimming against the current". When you are long, you're going with it.

RadAudit
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Re: Shorting - Can Someone Explain

Post by RadAudit » Sun May 06, 2018 11:09 am

lack_ey wrote:
Sun May 06, 2018 10:31 am
It's pretty much ... not something much riskier or prone to more gains or losses.
OK, I'm going to possibly disagree with this one. But, I probably have a lower risk tolerance than you do.

As I understand it, if I'm long an asset and the market moves against me, I could lose 100% of the investment. If I short an asset and the market moves against me, I could lose a lot more than that if I couldn't close out the trade quick enough.

Seems that a lot more babysitting is required in shorting a stock to mitigate the risks to an acceptable level.

What did I miss?
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The Calvary isn't coming, kids. You are on your own.

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Re: Shorting - Can Someone Explain

Post by inbox788 » Sun May 06, 2018 11:38 am

Sell High, Buy Low!

We have this mistaken belief that stocks only go up, when if fact they go up or down. When a stock is going down in price, you can make money selling it first at a higher price, and buying it back when it's lower. If the market is in a bubble and you fear it's going to crash, and sell out. Then when the market does crash, and you buy it back, you are in effect going short. Goes without saying, this doesn't always work out.
JoMoney wrote:
Fri May 04, 2018 2:51 pm
What others have said, but I'll add that "naked short selling" is illegal...
AFAIK, naked short selling isn't illegal, but it does expose you to risk that goes beyond embarrassment.
In 2008, the SEC banned what it called "abusive naked short selling"[2] in the United States, as well as some other jurisdictions, as a method of driving down share prices. Failing to deliver shares is legal under certain circumstances, and naked short selling is not per se illegal.[3][4][5] In the United States, naked short selling is covered by various SEC regulations which prohibit the practice.[6]

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Re: Shorting - Can Someone Explain

Post by lack_ey » Sun May 06, 2018 11:49 am

RadAudit wrote:
Sun May 06, 2018 11:09 am
lack_ey wrote:
Sun May 06, 2018 10:31 am
It's pretty much ... not something much riskier or prone to more gains or losses.
OK, I'm going to possibly disagree with this one. But, I probably have a lower risk tolerance than you do.

As I understand it, if I'm long an asset and the market moves against me, I could lose 100% of the investment. If I short an asset and the market moves against me, I could lose a lot more than that if I couldn't close out the trade quick enough.

Seems that a lot more babysitting is required in shorting a stock to mitigate the risks to an acceptable level.

What did I miss?
There's more risk in the sense that the exposure grows as losses do. Shorting 100 shares of a $10 stock is a negative $1,000 position. If it doubles to $20, that position is negative $2,000 and now constitutes a larger bet.

I think people are overly fixated on the prospect of losing more money than initially invested. The initial amount is not that important or relevant. Mark to market and consider the present risk exposures. To the extent that X is risky, so too is -X. It's not some entirely different, strange creature. Undiversified, narrow bets on volatile assets are risky either long or short. Shorting is not necessarily that risky, just as long investing is not but can be; it depends on what is being shorted and the overall strategy and exposures.

In any case, needs of portfolio maintenance do not factor much into an assessment of whether something is "a great way to either make a ton or LOSE a ton."

RadAudit
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Re: Shorting - Can Someone Explain

Post by RadAudit » Sun May 06, 2018 12:09 pm

lack_ey wrote:
Sun May 06, 2018 11:49 am
Shorting is not necessarily that risky, just as long investing is not but can be;
Thank you. That explanation helped a lot.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The Calvary isn't coming, kids. You are on your own.

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Re: Shorting - Can Someone Explain

Post by InMyDreams » Sun May 06, 2018 2:36 pm

Boxtrap wrote:
Fri May 04, 2018 12:38 pm
Can someone please explain short selling to me?
Watch The Big Short. Entertaining education. Should be required for every high school student.

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