Long investing is straightforward, you buy a stock at $X/share, and aim to profit because its price rises to more than $X/share by the time you sell it.
“Buy Low/Sell High” is Wall Street’s lullaby. And that is what most people understand what investing in the stock market is. But, there is much more to it.
The stock market does not exist to make everyone’s dreams come true by buying stocks and forever holding them. Yes, that happens often over time, but that is not why companies “go public” and list their shares on stock exchanges.
A Key reason the stock market exists and functions is because it provides carriable liquidity to investors.
You cannot buy a piece of a small business by just putting money down. Same with a piece of real estate. There is a transaction process, with steps contracts, lawyers, insurances and funding. It takes time.
The stock market cuts through all of that, and allows an investor to own shares of public and in some cases private companies by simply going to your brokerage account via computer or smartphone, and entering a buy order between 9:30a and 4:00p ET from Monday-Friday. That is liquidity you can plan around, that is the stock market.
However, the market is also about measuring the value of the businesses that are listed on it. And, while most investors look for stocks in businesses to buy that will go up in price, short sellers pursue profits differently.
They look for businesses that the market overvalues, and based on their analysis believe that a stock selling for $X/share is worth much less than that. And so, they cannot profit by buying the stock. And if they do nothing they miss an opportunity to capitalize on their research.
Instead, they go to the brokerages houses that hold the stocks (they are all listed) borrow shares, pay interest, and owe that stock back to the broker when the short is covered.
If the stock price goes down, those same shares will be worth less than the short seller received on the trade. That allows them to repay those shares plus interest to the broker. Thus, covering the short sale, and completing the round-trip transaction.
The transaction is similar to buying and selling, the difference is the mechanics and the risk. When an investor buys a stock, the most that can lose is the amount of cash invested.
But, when when an investor borrows stock to initiate a short sale, the loss is not capped.
Example, if the stock was shorted at 1 and went to 10 the short side investor owes that stock back to the lending broker meaning 9 has been lost. The lender is the big winner, it earned interest on shares loaned, and saw the value of the shares go up 9X. Note: if the loaned stock is a clients the broker does not give the interest to the client, and if the shares loaned belong to the house has earned the interest.
So, the big winner is the brokerage house, it has no risk. There is a little known fact that the bottom of the major Wall Street brokerage houses has been significantly enhanced by their short-side trading departments.
Putting this in the context of recent stock market headlines
The hedge fund managers who shorted certain stocks did so because they believed those companies would eventually be worth much less than they were when they initiated their short trades.
Based on the outlooks for those companies, given the realities of the medical emergency chaos and the market conditions the short selling hedge fund managers saw this as a way to profit from their research.
Shorting the market is not a scam.
Shorting is not a scam.
Shorting is an investment position based on someone having a different opinion about a company’s stock than someone else.
For those that do not invest for the long-term the stock market as a money making tool with attendant risk. Is a very good tool for pursuing your personalized investment objective.
What happened in the recent case of Wall Street short sellers Vs brigades of regular Joe’s and Jane’s is perhaps the worst-case scenario for those who try to profit by scoping out stocks overvalued businesses.
The Big Q: Why?
The Big A: Because the army did not care about anything other than the fact that those stocks were heavily shorted by professionals.
The Generals of that army did the research, and the soldiers followed, and there is nothing illegal about that action, as there is nothing illegal about shorting a stock unless it is done ‘naked‘.
Naked shorting is the illegal practice of short selling shares that have not been determined to exist, and that by the way is done regularly on the Street and has been done for decades.
Since the wildly publicized shorting events of January 2021 will not be forgotten it is better that people understand it than not before getting caught up in the fever.
Greed is contagious: the Fed has pinned rates to Zero and margin loans are ultra-cheap and easy to get. There is nothing like the thought of turning $200 into $100,000 in a short frame to make people greedy.
“When the market is greedy, you get an uptrend“– Jesse Livermore
Why? Because the last glands to go are the Greed Glands. “
Have a healthy week, Keep the Faith!