I kind of have an understanding of how shorting works.
Basically you sell the share in question, with an obligation to buy it back at a future date, hoping that the share goes down in price, the difference being your profit.
My question is…why does this exist?
Seems to me, some sort of casino-esque betting game.
Shorts exist because there are people who want to buy them and people who want to sell them. The reason for this is people have different predictions about which direction the share prices are going to move.
Other way around. You commit your self to sell, at a future date and for a fixed price, a share that you do not currently own. You are banking on being able to buy the share in the meantime for less than the price at which you have agreed to sell it.
But, yes, you are gambling on the share price declining. If it rises, you’ll lose money.
Is this a “casino-esque betting game”? I don’t see that it’s any more risky than buying a share in the hope or expectation that the price will rise.
No, this is a put option. Puts can be used for similar purposes as shorting, but they are not the same. To sell short you borrow something, sell it, and hope to buy it back at a lower price when you need to return it.
Short-selling is in fact more risky, because your potential losses are unlimited. Taking a long position (buy & hold) only risks the amount of money you put in.
Seems to me, some sort of casino-esque betting game.
Any time you risk money on an event with an uncertain outcome, you’re gambling - whether you call it playing the stock market, roulette, or a first date.
Aren’t there complicated transactions where you buy and short the same shares in a way that limits your potential loss?
One take on an answer to that piece.
There are a lot of trading strategies designed to insure against big losses. The simplest is a stop order: you buy a thousand shares of XYZ at $10 each, but tell your broker to automatically sell them if the price should drop below $8. Therefore your losses are limited to $2000 of the $10,000 you invested. (Assuming your stop order is executed immediately. Sometimes it takes a few minutes and the price can fluctuate in that time.)
Another way is to use options. Say you have have a thousand shares of XYZ which is currently worth $10,000 (so $10 per share), and you want to insure against some losses. You could buy ten put options (each contract is worth 100 shares) with a strike price of $9 which expires next month.
If the price of XYZ goes up, then the options expire “out of the money” and just disappear. You lost the money that you paid for the options but made money in the underlying equity.
If the price of XYZ goes down below $9, you can execute your options at the end of the month to sell your stake for $9,000. You’ve lost the $1000 in equity from XYZ, plus the amount you paid for the puts, but potentially limited your losses if XYZ crashes.
There are more complicated options strategies as well. They can get confusing really quickly. I wouldn’t really recommend any of them for 99% of investors.
This is exactly the mentality that fucks many amateur investors.
Sell when it drops, buy when it’s high. What is the logic in that?
If you’re a real player you buy when it drops and sell when it’s high.
Like Friedo said, short selling is basically selling borrowed stock at a higher price NOW, with the expectation of being able to buy it back (and thereby give it back to whoever you borrowed it from, surely for a small fee) in the future at a lower price.
Short selling is just the flip side of the more traditional “Long” position, where you buy a stock at a perceived low price with the expectation that it’ll rise in value, and you’ll sell it later and realize that gain in value.
A person buys a stock at $10. Now what?
It may go up and all is well. But what if it goes down? You have several strategies for dealing with that contingency. You can hold the stock and hope that at some time in the future it goes back up, but that ties up your money for no return for a long time. You can watch it hit bottom and sell at its worst assuming that it will never get better. Or you can see it drop a small amount, take your losses and move the money to a hopefully better investment. Obviously the last one, a stop order, is the best of those choices.
You have to assume from the start that some of your choices won’t work. Nobody ever buys only stocks that go up. (Buying when it drops and selling when it’s high is timing the market: you can’t time the market continuously.) Limiting loss to a manageable amount is the smartest strategy.
There are a few reasons to short beyond pure speculation (although most/all trading strategies have speculative components regardless of the type of instrument used).
Here are some examples:
You are arbitraging a stock traded on two different exchanges - you see that there is a slight difference between the price it trades at on the two exchanges and so you go long on the exchagnge where it trades for less, and short on the exchange where it trades for more, with the expectation that the price will converge (it doesn’t even need to meet in the middle, it just needs to even out).
You are doing something similar to the above but with a less concrete tie - such as two companies you think may merge, two companies you think should be valued similarly, two exchange traded commodities that you think should have a greater amount of substitutability, two exhange traded funds that have very similar makeups, or whatever.
This is a good strategy to use if you think you’ll need to sell the stock at some point, but don’t want to right now. I did this when I needed a chunk of cash for a remodel. I shorted the stock to make sure I would have the needed cash 6 months out if the stock price dropped. As you say, it’s like taking out an insurance policy.
And I got lucky. The stock dropped, I made a chunk of change and didn’t have to sell the stock. so I could keep it and eventually it recovered. Had the stock not dropped, I would have lost all the money I put into the options, but hey, to do feel bad that your house didn’t burn down just because you have insurance against that?
One aspect of trading short that is more risky than trading long is that theoretically there is no limit to your potential downside. If you bought a long position, the most you can possibly lose is the amount you paid for your shares. In a short position, if you guess really wrong, there’s no limit to how high the shares might shoot up by the time you have to cover.
As others point out, short-selling is just another way to pursue Buy Low Sell High … except that the temporal sequence is reversed! There’s huge short interest in many NYSE stocks. I hope one of the SDMB stock trading experts will comment on the scale of these massive short interests, and what their side effects are.
Non-“casino” sorts of shorting are possible. For example IIRC, Helena Rubinstein shorted a large number of shares of her own company, Rubinstein. She didn’t short “against the box” (i.e. turn her own shares over to her broker as collateral, so the sale could proceed) but rather borrowed them from a relative. IIRC the purpose of this was to avoid capital gains tax that result from an ordinary sale. (If the intent is to cover soon, this seems not unreasonable and AFAIK may even still be allowed by IRS in well-defined cases.)
As practical advice for amateur investors (such as myself) it’s important to note that the smallest and largest players are very different in what they can do.
A big player might short 5 million shares of AAPL naked, receiving $580 million dollars. He’d have to pay out the 2% dividend to the stockholders whose shares he borrowed, but would be out only 1% net, if the broker paid him 1% on his cash balance. (This is clearly reasonable; if you borrowed to buy, your dividends would help offset your cash interest payments. Though retaining control of your cash for collateral, the broker will certainly be putting it to work.)
A little player would not receive interest (excepting a few generous brokers) on the cash (a huge difference unless interest rates are very low), nor would he be allowed to short naked. (Regulations have tightened; is naked selling still going on?) Because of these and other disadvantages, I think small customers who want to gamble are better advised to buy puts. Experts?
The question is unclear. Are you asking why people like to gamble? Or whether short selling serves a public interest?
In its purest forms, short selling is a “natural” act which it would over-authoritarian to ban. And most of us agree that serving the public interest is unnecessary for any mechanism, as long as it does no public harm. (Companies whose shares are shorted sometimes complain that it harms them, but is that harmful to the public? Some would argue, I think, that in those cases the shorters may be serving the public interest, by discouraging investment in an overvalued firm.)
There are stock trading practices which do pose risks to the public, and should be regulated or taxed. But short sales wouldn’t even make the (well) short list of such objectionable practices.
IIRC, something like 90% of all option plays (puts and calls) end up as losers. This is not for the faint of heart.
Much option play is designed to prefer, e.g., a safe 8% vs a less sure 10%.
Strictly, what he is talking about is a forward. The distinctions are:
[ul]
[li]A put option gives a right, but not an obligation to sell at a given price at a given expiry date (European option), or on any date before the expiry date (American Option) or on one of small number of dates (Bermudan option). If the market goes the “wrong way” (e.g. the spot price of the equity is higher than the strike price of the option) the option holder doesn’t have to exercise.[/li][li]A forward obliges a transaction to occur at a given date at a price that is agreed upon now. Unlike a put, the sale will happen no matter how the market moves in the interim.[/li][li]A short position doesn’t have any particular expiry date. Most of the time, you can hold a short position open indefinitely so long as you can post enough collateral to your broker to cover your losses and can keep finding people whom you are nominally “borrowing” the equity from.[/li][/ul]
I studied silver for a while, I figured that with a 10,000 dollar initial investment, one could make close to 2000 dollars a month, but you’d have to be on it full time. There are regular dips and spikes caused by people with much bigger investments doing the same thing, you just have to watch the trend and piggy back on it… and most importantly, rid yourself of the notion of selling low and buying high.
To be blunt, no way. Your theory wouldn’t work in real life. It’s easy to sit back and watch and tell yourself “If I had bought this amount on this day and sold that amount on that day, I’d have made two thousand dollars.” But when you’re trying to do this in real time, you’d find the decisions are not as obvious.