How to Short Stocks

[fusion_builder_container type=”flex” hundred_percent=”no” equal_height_columns=”no” menu_anchor=”” hide_on_mobile=”small-visibility,medium-visibility,large-visibility” class=”” id=”” background_color=”” background_image=”” background_position=”center center” background_repeat=”no-repeat” fade=”no” background_parallax=”none” parallax_speed=”0.3″ video_mp4=”” video_webm=”” video_ogv=”” video_url=”” video_aspect_ratio=”16:9″ video_loop=”yes” video_mute=”yes” overlay_color=”” video_preview_image=”” border_color=”” border_style=”solid” padding_top=”” padding_bottom=”” padding_left=”” padding_right=””][fusion_builder_row][fusion_builder_column type=”1_1″ layout=”1_1″ background_position=”left top” background_color=”” border_color=”” border_style=”solid” border_position=”all” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding_top=”” padding_right=”” padding_bottom=”” padding_left=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”small-visibility,medium-visibility,large-visibility” center_content=”no” last=”true” min_height=”” hover_type=”none” link=”” border_sizes_top=”” border_sizes_bottom=”” border_sizes_left=”” border_sizes_right=”” first=”true”][fusion_text]We all know that we can make money as the stock market rallies, but not everyone knows you can make money when it crashes.

The concept of ‘short selling’ is really as simple as that. It can be incredibly profitable, but it will almost always make you unpopular.

First and foremost, you may be curious about how to short stocks on the open market. Before getting into that, though, it is critical to understand that this is a very risky, extremely uncertain way to make money. Not sure if it’s right for you? Fine then, just don’t do it! With limited profit potential and unlimited loss potential, it has to be something that you’re certain you want to do before getting into it.

With our disclaimer out of the way, let’s talk about how it’s done.

What is “Short Selling”?

The process goes like this: You expect the value of a company to go down, so you sell shares that you don’t actually own by “borrowing” them from another investor. You have an obligation to buy them back in the future to “return” them to the investor, so when you sell, you’re guaranteeing that you will cover this sale. If the value of the stock/company has gone down in between the time of sale and the time of purchase, you make a profit equal to that amount (minus any associated fees); however, if you were wrong and the value has stayed the same or increased, you will be in the red.

The risk here comes from the potential for a company to go up or down – theoretically, a company could increase in value forever, thus putting you on the hook for an indeterminate amount of money, whereas the lowest it can go is zero, limiting the amount that you can make.

Something about making money as the world burns is not exactly a universally loved concept. However, not only is it extremely important for you to understand… many argue that it’s actually incredibly important for a well functioning financial system.

The Collapse of Enron

When Enron became exposed for its shady accounting practices, it was in the limelight as one of Wall Street’s darling companies; people were making buckets of money from their Enron stocks and the company just kept growing… but it was completely unsustainable. There was no tangible value to support the inflated valuation that it had and executives were cashing out before the public could find out.

Famous shorter Jim Chanos analyzed the company’s accounting practices, decided to take up a short position against them, and told everyone to do the same. This was one of the main catalysts for their exposure and subsequent fall from grace… but what do you think? Was Chanos helping others through his exposure to the company? Or did he just profit off a bad situation? That is the question short-sellers must answer to themselves and the public.

“Short sellers are the professional skeptics who look past the hype to gauge the true value of a stock.”

– (In)famous Enron Short Seller, Jim Chanos

There are, however, other investors that take short positions against companies that aren’t necessarily shady but instead, that they feel are artificially trading above their worth. This could be a product of too much optimism, exaggerated claims, or myriad other reasons.

The most commonly shorted modern company today is Tesla, with investors continuously saying that it’s worth too much, hasn’t proved its worth, or just generally isn’t as valuable in reality as it is on paper. Jim Chanos is on record calling Tesla a “walking insolvency” and that it’s headed straight for bankruptcy.

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