Short Selling Explained

Originally posted on 21stfinance.com

In Episode 9 of Taking The Over, Jared, Gunnar, and I were talking about how Bill Ackman placed a massive short sell on Herbalife.

For those of you that aren’t really sure what a short sell is, let me explain.

Simply put, placing a short sell on a stock or investment means that the investor thinks the price of the investment will go down. When it comes to short selling, the investor doesn’t own the stock at the time, and in a sense they are “borrowing” the stock. When the price goes down on the “borrowed” stock, it is then bought back at a lower price, creating a profit.

Consider the following example.

A trader believes that stock A, which is trading at $50, will decrease. The trader “borrows” 100 shares and sells them. The trader is now “short” 100 shares of A, since the trader has sold something that they didn’t originally own. The short sale was only made possible by borrowing the shares, which the owner may demand back at some point.

A week later, stock A reports news that is detrimental to the company, and the stock falls to $45. The trader decides to close the short position and buys 100 shares of A at $45 on the market to replace the borrowed shares. The trader’s profit on the short sale before taxes and trading commissions would then be $500.

For more information on investing basics, check out investopedia.com

-JP