The Ban on Short Selling

Many folks will have seen this article or one similar that talks about the ban on “short selling” of financial stocks. That raises the question, what is short selling?

Short selling is a way of betting that a stock will go down. If you own a stock and you think its value will go down, you would probably sell it. That’s a long sell. But even if you don’t own the stock, you can sell it. When you enter a sale as a short sell, you borrow someones stock (you don’t really know who’s, you just borrow outstanding shares) and sell them, with the open ended promise to buy the stock back at a later, unspecified date.

Let’s say I want to short 100 shares of XYZ. For our purpose, the stock is trading at $100. I short the stock at that price. If the stock falls to $80, and I buy back 100 shares, I’ve covered the borrowed stock and made a profit of $20 per share. That’s a quick $2,000 in my pocket and I still don’t own any stock. That’s the classic short sell strategy.

But the problem is, some stocks don’t always fall when you think they will. What if the price of XYZ goes up to $120? Well, I’m $2,000 in the hole. I would have to decide whether to take my losses, or hang on to the position and keep hoping that the stock would fall again. It is kind of like doubling down.

Update: I fixed the math. Hey, what can I say? I’m a moron.