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Basic shorting

When you short a stock, you are betting that the price of the stock is going to decrease. In this video, learn about the basics about shorting stocks. Created by Sal Khan.

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  • leaf green style avatar for user Ray
    Why are you allowed to sell something that you borrow? Also if I do sell something that I borrow there are now 2 people that think that they have 100% ownership of the same thing. Did I just create an imaginary stock?
    (83 votes)
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    • aqualine ultimate style avatar for user micahneely
      Think of it this way. You lend me a sandwich and I immediately sell it for $5 promising you I will return an equivalent sandwich someday. Meanwhile, Oprah says everyone should eat tacos instead, and the price of sandwiches drops to $2. I buy a $2 sandwich and pay my sandwich debt to you yielding me a $3 profit minus whatever interest you were charging.
      (236 votes)
  • blobby green style avatar for user julia hathaway
    looks like this video is a follow up to some previous lesson, anyone know what that lesson/video is?
    (26 votes)
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  • blobby green style avatar for user Ben Stamer
    I wonder how naked short selling works, i.e. selling without borrowing the stock? How do you do that?
    (14 votes)
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    • leaf green style avatar for user Monty
      Naked short selling means that the firm is short selling the stock without locating a borrow. I think it is illegal and theoretically more shares can be shorted than exist.... this was alleged by some smaller companies such as Overstock
      (7 votes)
  • blobby green style avatar for user Karam  Abdulla
    is it possible to borrow the stock and then sell it without buying it later when it goes down. You will get the entire price of the stock without buying it in the beginning.
    (7 votes)
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  • purple pi purple style avatar for user Arcbound Ravager
    Isn't it true that you need to set up a margin account of which your broker has control when you short securities.
    (3 votes)
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  • leafers ultimate style avatar for user Jonathan
    Why don't people just buy the stock, and actually own it, and then sell that stock? that way you would have no obligations to buy it back.
    (3 votes)
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  • blobby green style avatar for user Max Whitlock
    What is the benefit of the other party lending you that stock? If they are literally just giving it to you for you to then return it at a later date at the same value what is there incentive to lend it whilst you go off and attempt to short it and make money?
    (3 votes)
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  • purple pi teal style avatar for user hiabc
    Why would people short? Also, do the people who are shorting have to tell the real owner/lender that they are shorting the stock? Third of all, is there interest? Like if I lent my stock to Person 1, and the stock is worth $50, would the person have to pay me back with interest or not? Because if there's no interest, I don't see why people would lend THEIR money, when there's risk of bankruptcy and no chance of profit. Finally, who decides the interest (if there is interest at all)? Thanks!
    (2 votes)
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    • male robot hal style avatar for user Andrew M
      If you think the stock is going to go down, you might want to be short.
      The owner, or the representative of the owner, knows that the stock has been borrowed.
      The borrower pays interest. When you own stock in a brokerage account, typically your deal with your broker allows your broker to lend out the stock and keep the interest. If you are a large customer you might be able to negotiate a deal where the interest comes to you.
      The lender is not lending money, the lender is lending stock, and there is no risk to the lender because the stock always remains in custody of brokers, and the short seller always has to maintain more than enough equity in his account in order to cover the cost of buying back the share to return them.
      (4 votes)
  • leafers ultimate style avatar for user Caleb Matanui
    The only question I have is this: What if you want to buy the stock back, but the other person isn't willing to sell it? Then what happens?
    (2 votes)
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    • blobby green style avatar for user Michael de Guzman
      This can happen on a large enough scale (eg it seems like no one wants to sell), and what occurs is called a "short squeeze". Basically, if you short sell a stock that has a binary positive event (a drug passes clinical trials, it gets a big acquisition offer) then tons of people want to buy the stock. However, if the stock is one that is heavily shorted (a lot of people also bet against the stock) and doesn't have a ton of shares outstanding, then tons of people will be looking to cover their shorts while no one will want to sell (because the stock keeps going up). In this case, the price can rise very rapidly, much higher than seems reasonable even given the good news. The price will typically recover down to its fair price eventually, but that brief period could wipe you out entirely. This happened in 2008 when Porsche offered to buy the balance of VW, VW was heavily shorted, everyone tried to cover at the same time and no one wanted to sell and VW shares went from about 200EU to over 1,000EU and for a couple of days VW was the most valuable company in the world.
      (3 votes)
  • blobby green style avatar for user JDiaz1001
    How does the person who originally owns the stock(who's stock is being borrowed) profit?
    (2 votes)
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    • male robot hal style avatar for user Andrew M
      Actually, in the majority of cases, the person who lends the stock does NOT benefit. The fee that is collected from the borrower is kept by the broker. Check with your own broker or read your brokerage contract to find out whether your shares can be lent and if so who gets the fee. Generally only very large investors get to keep the fee.
      (3 votes)

Video transcript

Let's say you don't like company ABCD very much and you're convinced that the stock is going to go down. So in that situation, you can actually short the stock, which in a very high level is a bet that the stock is going to go down. And the way that you do that mechanically is that you borrow the stock from someone else who owns it, and then you immediately sell that stock that you don't even own. You sell the stock that you borrowed from someone else, and you'll sell it at the current price. So, for example, in this situation, you would sell it at the current trading price of $50. You would then hope that the stock price goes down. Let's think about the situation where the stock price goes down. So if you shorted it right over here, you borrowed the stock and you sold it for $50. And then if the stock were to actually go down-- let's say it goes all the way down to $20, and you think that's about how far it's going to go down, then you can buy back the stock for $20 in this situation. And then give it back to the owner. You had borrowed the stock. Now you can hand back the stock to the owner. So you could give it back and you've essentially unwound it. And what it allowed you to do is it allowed you to do the buying and selling in reverse order. Normally before you sell something you have to buy something. But here you were able to sell it and buy it later for a lower price. So the situation where the end price is $20 you had sold it for $50. So you got $50. And then you had to use $20 of it to buy it back. So in that situation, shorting the stock, you would have made $30. Let me write this column here. This is the short option. You sold at $50. You borrowed and sold at $50. Then when it went down to $20 you bought it back for $20. So you had $50 of proceeds. You had to use $20 of it to buy it back. So you had a $30 profit. But that's only in the good scenario. What happens if your bet is wrong? What happens if the stock price goes up to $80? And over here you get so scared. You're like, oh my god, I have to buy the stock back by $80. What if it keeps going up? I could lose an unlimited amount of money. So over here you get scared and you unwind your situation. You say, OK, I'll go and buy the stock for $80, so I can give it back. So in this situation where the stock goes up you actually could lose a lot of money. You had sold it for $50. So you only have $50 that you have from the transaction. But now you have to buy the stock for $80. So if you sold for $50 and you buy for $80 you've now lost $30. You're $30 in the hole. So now you are at negative $30. And really shorting is the riskiest of all of the things you can do, because a stock price and go unbelievably high. What happens if the stock price goes to $800 or goes to $8,000? All of a sudden, you've sold something for $50 and you have the obligation at some point in the future, because you have to give the stock back, of paying $500, or $800, or $8,000. You don't know how much you'll have to lose. So it's really the riskiest thing you can do. But it is one way to bet that a stock price will go down, or profit from a stock price going down.