Investing Explained: What You Need to Know About Short Selling When Investors Buy Stock in a Company Thinking the Price Will Fall
In this series, we distill the jargon and explain popular investment terms and themes. Here is the short.
what is that?
Investors usually buy stocks because they like the prospects of the company.
This is in contrast to short sellers who believe that a particular company’s stock will tumble due to the incompetence of its manager or its poor prospects. Typically, they borrow these shares from fund managers in exchange for a fee and then sell them. When stocks fall, short sellers buy them back at a lower price, making a profit along the way and returning them to their owners.
There is no guarantee that the stock price will crash, and it is a high-risk activity. In addition to stocks, it is also possible to short other financial instruments and stock market indices.
Who’s Shorting?: Hedge Funds and Other Large Financial Institutions with Infinite Loss Resources
Who are the short sellers?
Hedge funds and other large financial institutions with unlimited loss-incurring resources. A list of short-selling stocks is available online.
Companies featured prominently on the list are Cineworld, Carillion and Hammerson. The Argonaut hedge fund, which has been shorting Cineworld for four years, says the company is building an “empire of the sunset industry.”
Is ‘The Big Short’ realistic?
Based on The Big Short: Inside The Doomsday Machine by Michael Lewis, the film was released in 2005 when Michael Burry of California hedge fund Scion suspected the U.S. housing market was in a bubble. This is a true story of how it happened. Barry’s strategy was basically to short subprime loans that were packaged and sold to investors. He earned millions. Now, and ominously, he is predicting a stock market crash and is selling all his shares.
What is short squeeze?
If the stock price rises sharply instead of falling, sellers rush to close their positions and buy back shares to limit their losses. This drives the price up even further. Some of the recent Wall Street rally is said to have been caused by hedge funds covering short positions.
A basket of “most shorted stocks” including retailer Bed Bath & Beyond rose as much as 49%. The beneficiary of his Bus & Beyond price spike was 20-year-old student Jake Freeman, who made $110 million.
I’ve heard about ‘naked shorts’
It may sound like a very bad practice, but it involves selling unborrowed shares. Very risky and very frowned upon by regulators.
It gives me courage…
You can short the FTSE 100 by investing in Legal & General and Wisdom Tree Exchange Traded Funds (ETFs). Various brokerages allow retail investors to short-sell, but warn that it is best left to large institutions. Those who cannot tolerate unlimited losses should stay away. So many hedge funds are losing money this year that even experts get it wrong.