Can someone explain what shorting stocks means?

I am no financial expert, but this is my understanding. You pay someone to borrow their stock for a certain period of time. You immediately sell the stock in the hope that the value will decrease. You can then buy back the stock at the lower price and return it to the person you borrowed it from. It is very risky, because there is no limit to how much you can lose. If the stock price goes way up, you have to pay it in order to return it to the person you borrowed it from.

It was explained on CNN as @LostInParadise explained it. My only question is how do you borrow stock?
Apparently, it’s a legal practice unless there is some collusion to drive down the price of a business so you can drive it out of business or swoop in and buy it for cheap. But it’s usually done when they think a business is already failing and they believe the stocks are going to fall. Game Stop wasn’t exactly thriving before Covid and it seems most of their business now has gone to online. because of Covid.

You are betting that a stock will lose value.
There were several people who made a lot of money by shorting the stocks for United Airlines and American Airlines just before 9/11.

Why would the “lender” let you borrow the stocks? Wouldn’t they know that the borrower is hoping to pay back at a lower rate?

I think the whole idea of borrowing stocks is confusing the issue. Selling Shorts is merely selling stock you don’t own for delivery at some future date in hopes that the stock will go down and you can buy them before the delivery date, at a lower price than what you sold them for. The big Hedge Funds can sell a lot of stock which in itself will put downward pressure on the stock. More sellers than buyers will always do that. What happened with Game Stop is that a group of investors got wind of what they were doing and began buying up all the shares. More buyers means the stock gets upward pressure. As the delivery date approached the hedge funds began panic buying to fill the shorts they had sold, driving the stock price even higher. Once the delivery dates for all these shorts passes, the stock should return to normal and anyone still holding stock they bought at $300 will lose their ass.

Stock loans are a way for long term holders of a stock to make a bit of extra money. It is a legal and accepted practice.

Up until about 12 years ago, one could short “naked”, I.e., without borrowing the stock and with the expectation that you would buy in your short position before you needed to deliver stock to the person you sold it to. But that resulted in too many fail to deliver, and the SEC wanted to end fails. Now you have to arrange to borrow stock before you can sell short.

Shorting was more complicated twenty years ago, because the New York Stock Exchange had an uptick rule: you could only sell short on an uptick, a price higher than the last change in price. But when Bernie Madoff was running Nasdaq, he pointed out that Nasdaq could not determine if the last sale was an uptick or not, because it was a network of independent dealers. So the rules got changed.

Short selling was how Joe Kennedy made millions in the late 1920s, and one of the practices he clamped down on as the first Chairman of the SEC.

@Jaxk The GME situation was a bit skewed, as the short position at the end of December was 102% of the float; more stock was sold short than was available. And the settlement date for stocks is trade date plus 2, so trades from Tuesday of last week settled on Thursday. That’s why Merit Capital had to refinance itself, because it had to cover billions in losses.

While the volatility in GME may decrease considerably in the coming weeks, it may take months for the price to get down closer to a fundamental pricing based on earnings. GME was a $4 stock for most of last year.

@zenvelo – I have heard the same thing about GME and it’s been a long time since I’ve done any short selling., too dangerous for my taste.

@janbb , The lender gets paid for the right to borrow and is obviously hoping that the value of the stock will rise.

GQ, Jan.

I’ve actually read a couple of books about the stock market and returned again and again to articles on elusive major topics (such as “market cap”) because I used to work for a company that was/is very big on NASDAQ.

This is one of the principles that baffled me. I still can’t hold it in my head. Is it too much to hope for an encapsulation that has a clear logical side to it, so it coheres as a concept?

Here is a link to a definition of short-selling. It seems to line up with what I said. What is the difficulty in understanding it?

@LostInParadise Good article. Some of it is over my head but I get the basic concepts now and from your first post.

The question itself demonstrates the real mess we have with our financial sector. As with the savings and loan scandal, the housing collapse, Enron, Bernie Madoff, etc. We are ALL going to understand rather soon (and of course too late) exactly what loose regulation of our financial sector casino has bought us. This Game Stop business can topple the entire house of cards.

Here you go
https://twitter.com/halhickel/status/1354580180182855682?s=20

@Caravanfan Yeah, I could have probably done as good a job as she. :-)

I think I get it now too, but it probably won’t stick.

I understand some things that don’t stick with everybody. I know when to use “its” and “it’s,” and I’m not confused about “who” and “whom” or when to use “lie, lay, lain” versus “lay, laid, laid.” I guess I have receptors and a framework for those things. Other people have receptors and a framework for things that I don’t store successfully.

So I’m really glad we can share our expertise with each other.

@stanleybmanly But this part of our financial sector isn’t in a mess unless you are a fat cat hedge fund manager who has been on the wrong side of the reddit masses.

Gamestop (Ticker GME) was a four dollar stock up until last August. They hired someone who is known for turning companies around, and also there was speculation that they could sell a lot of game platforms (Playstation,, X Box) that had new versions coming out.

But the fundamentals of Gamestop are weak: they are based mostly in malls, which is a dying retail model, and they sell game cartridges, while most big popular games are sold on line to be downloaded.

So GME became a favorite short of some hedge funds. And some reddit traders all said “whoa, this is so oversold, it has to go up”. There in lies the difference of opinion.

Along comes Robinhood, which has greatly democratized investing by giving people an app and fostering low capital investing. In the old days, you would usually have to buy in 100 share increments, and your would have had to $30 to $60 commission to get in and again to get out. Now you pay no commission, and you can buy fractional shares. (Fractional shares: for a $10 investment, you can buy .076 shares of Apple. $10/$131 per share = .076 shares)

And, with the power of social media, a lot of little guys can counteract the machinations of a couple big hedge funds. A lot of people under the age of 35 remember Gamestop with fond memories, it was there go to place to get new games and sell back ones they no longer played.

But that is the controversy that threatens to blow the entire thing up. Robinhood with its reputation for enabling the little guy is now caught red handed in league with Melvin Capital and Citadel by limiting the shares of GME for purchase to these same little guys who have the hedge funds over the barrel. Tenev claims Robinhood does not lack the capitalization to broker the deals, so why the down throttling while other brokers feel no such compulsion. The fact that Robinhood earns money through steering information to Citadel which just happens to finance the bailing out of Melvin Capital should mean SOMEBODY’s going to jail. But Gamestop isn’t the end of it. Blackberry, and AMC are now on the block and the whole hedge fund business now teeters.

@janbb Maybe this will also help to simply explain it. From Motley Fool website.

Shorting stocks step by step.

1. Identify the stock that you want to sell short.

2. Make sure that you have a margin account with your broker and the necessary permissions to open a short position in a stock.

3. Enter your short order for the appropriate number of shares. When you send the order, the broker will lend you the shares and sell them on the open market on your behalf.

4. At some point, you’ll need to close out your short position by buying back the stock that you initially sold and then returning the borrowed shares to whoever lent them to you, via your brokerage company.

5. If the price went down, then you’ll pay less to replace the shares, and you keep the difference as your profit. If the price of the stock went up, then it’ll cost you more to buy back the shares, and you’ll have to find that extra money from somewhere else, suffering a loss on your short position.