What is short selling stock and can it make me rich? This is a question that I have to answer quite a bit in my financial dealings with new entrants. Let me start out with this follow thought. In a market such as ours in 2016, one may wake up one morning and find that his stock went through the floor, leaving him with the empty feeling of failure. “If only I had the foresight to sell the stock ahead of time, the man would not be more the richer this morning…I would be one dancing in the streets.”
This phrase, or one like it, has surely been shouted, uttered or at least reflected upon during many shareholder “mournings” (no pun intended) right after the corn flakes and right before the excruciating trudge to the office cubical. But I ask you…who is the man? Where does your hard earned money go? Does it go into cyberspace, other companies or to the brokerage firm? No way; Not a chance; Think again. So where does it go? Before you get hysterical and aim your next maniacal vandalism prank at Charles Schwab, you might want to first look over the cubical partition at the guy next to you who is laughing his butt off. Yes…that guy; the newbie who drives you insane during lunch because he chooses to eat his potato chips with his mouth open. While you’re reeling with disgust day after day, that guy is capitalizing on your misfortune. Yes…that guy is getting richer off of you!
How??? You may ask…
Welcome to selling short!
For example, I have a stock that I am shorting for a short period of time. This stock is Seadrill Limited (SDRL $3.93) and it is in big trouble. They are apart of the oil industry and are carrying quite a bit of debt. In my professional opinion, way too much. So what do you do to make some cash off of this? Short it of course and that is what I did. Did I make the right move? Only time will tell, but I do believe someone will be waking up going…”Where did my money go?”, and it won’t be me. (Update since I wrote this…the stock is now down to $0.00…if you listened, then you made some serious gains)
So what really is short selling stock? Selling short means that you borrow your buddy’s money and hope that his stock plummets! Obviously (or hopefully), your buddy isn’t your friend, but he is really some unsuspecting individual who did not have the insight to sell his stock before the aforementioned plummeting, but you did! How do you do it? It’s the same as applying for a loan… you need collateral. In the stock brokerage world, this is called a margin account. You can either use cash or your present stocks as collateral. You use your collateral to buy a stock that you think is just going to go through the basement and collapse upon impact. Then you ask your broker to take those shares and sell them to some unsuspecting individual who just may have had cornflakes for breakfast. Then you sit and watch… and you want the stock to go down! When the stock goes down, the money that the original owner had is now yours! But when do you pull the trigger and cash in? You could wait and hope that it goes even lower in its abysmal state because the lower it goes the richer you will become; but there is a risk…and your risk is that the stock could escalate faster than Russell Crowe’s beer muscles! So, in laymen’s terms, when you think your stock (that you sold short) has been beaten, pummeled, and ran through the wash…sell it back! You will get your collateral back plus the difference! What is short selling stock? This is a prime example.
Here’s an example…
In 2008, a group of employees at our company threw money together to obtain a large amount of stock in General Motors. My partners and I knew that they were more than unlucky because they were ignorant to the way things worked in today’s market, and we (and most people in America) believed that General Motors was due for a downfall that they could not survive. So, unbeknownst to our coworkers, while they were celebrating their ill-advised purchase, we were toasting to a prosperous future fueled by their misfortunes! What is short selling stock? This is, in all its glory.
So, since most highly touted novelists use an analogy to assist the general public in understanding…here is ours: Selling short is like trading an All-Pro line backer at the edge of his prime. Everyone will wonder why you did it at the time… but when he pulls up lame and retires the following year in a different uniform, everyone will think that you’re a hero!