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In a previous article, I explained how one aspect of the stock market works, in the plainest language I could. After talking to a few people, I realized that there was another, more basic function of the market, that a lot of people are confused about, and that is shorting stocks, or selling short. A lot of people don't really understand how you make money off of a stock losing money. In fact, it is very counter-intuitive (at least to honest people), so I want to try to illustrate it as simply as possible, with as little Wall Street jargon as I can. It really isn't that complicated, but the way people talk about it makes it seem a lot more cryptic than it really is. So, let's look at how you 'short' a sale. Say you are a camera buff, and have lots of friends who are camera buffs and professional photographers. One of your friends has so much equipment, he could never use even half of it. He has one lens in particular, that you are really interested in. The reason you are interested, is because it sells on Ebay for as much as $2,000, but you have heard a rumor that it is about to be replaced by a newer, better version. You know that when the new lens is released, the value of the current lens will drop through the floor, because everyone will be selling them to get the new one. So, you get an idea. You get your friend to rent you his lens for $10 a month, with the promise that after a set amount of time, for this example let's say three months, you will return it (or one just like it if something happens to it) to his collection. As soon as he rents it to you, it immediately goes up on your Ebay page for sale, and you end up getting $2,000 for it. Two months later, the new lens you heard rumors about comes out, just like you hoped it would. As you predicted, the old lens plummets in value, as everyone unloads them, and you are able to buy one for $500. You then return the $500 replacement to your friend, and walk away having made $1,500 on your $30 rental fee. You have just completed your first successful short. |
