How to Explain Short Selling to Your Mother!

Posted by Brian Lund in General Ramblings, Trading

Over the last few months, whenever I am asked at a social function what I do I respond “I trade stocks”, which usually prompts a “look” that ranges from pity to Schadenfreude.  This is usually followed by something akin to them saying “things must be pretty tough, huh?”  I of course respond that I am doing fine, because I can make money when the market moves down by……………

SHORTING…..!!!! (insert glazed look in conversationalist’s eyes).

My mother actually thinks that I am doing something illegal when I tell her I can make money if a stock goes down.  Personally I’ve never had an issue with the concept of shorting, which is probably why I trade.  But for others who don’t quite understand the concept I have developed a simple way to explain it.  It goes like this…..

A share of stock is a standardized instrument just like a book or a DVD, meaning each share of IBM is the same, just like every copy of “Harry Potter and the Deathly Hallows” on the shelf at the local bookstore is the same.

So let’s say your best friend just bought a brand new copy of “Harry Potter” and the moment he brings it home you ask him to borrow it.  Now that you have borrowed it from him, you owe him back one copy.

You then take the copy he loaned you and sell it.  Maybe you sell it on Ebay, maybe at a garage sale, maybe to an individual, it doesn’t really matter.  You get $25.00 for the book when you sell it.  You still owe your friend one copy of Harry Potter, so you order a copy on-line from a discount book wholesaler.  That copy only costs you $19.95.

The book arrives and you return it to your friend, keeping the difference between what you sold it for ($25.00), and what you bought it back for ($19.95).  You have thus made money by selling something you did not own and then buying it back (and replacing it) for less that you sold it for.

Short selling is the same concept, you just replace a share of stock in XYZ company for the copy of the Harry Potter book.

In the above example the venue you sell the book in could be various, but with the stock it is the open market.  If you were unable to buy the book back for the $25.00 or less that you sold it for you would have had to cover the difference out of your own pocket and thus lose money.  The same would go for the stock example as well.

If someone doesn’t understand the concept of short selling after this explanation, then they never will.

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  • http://www.facebook.com/theboxer5 Howie Truong

    In your example, you made a profit when the price went up to $25 when you sold it. But what happen if you can only sell it for $15? So you need the price to go up first to make a profit.

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  • Youreawizardharry!

    So my mom asked “why would a complete stranger loan you a copy of her book over the Internet?” And I [stupidly] said “I have no idea but I’m willing to bet it has something to with greed or fear.” Her look of disdain made me feel that this analogy is lacking a motive, which would be helpful in repairing my mothers opinion of my day time activities. Why do people offer their shares for borrow?

    • http://bclund.com/ bclund

      That’s a really good question, except I believe it’s not individuals who do it. I imagine brokers get some liquidity kickback or just want to make more options available to create more commissionable transactions.

      If you find out, drop me a line and let me know.

  • Blue Diamond

    I never post on blogs but I had to as I was laughing when I saw this. My husband just told my mother-in law I was day trading. She didn’t understand at all. She asked if it scared him. Yet as they say the proof is in the pudding. He finally ended the conversation with mom she makes more then I do most days. ( He is a professional scientist). Thank you so much for this post… now at least I have a plan for the inevitable shakedown over the holidays. I never thought of using an analogy. I just wanted to post something for new traders, however. I practiced for five years while in college before trading with real money. It is important to do so when you actually start trading emotion is not in play. Start trading (when your successful) and when you start thinking about the trades and the market each night, not the money.

    • http://bclund.com/ bclund

      You should get on StockTwits and share your experiences. We need more lady traders :)

      Thanks for reading.

  • Manto

    When you sell short must you set a date when the stock (book) has to be repurchased or can you buy back the stock at your choosing??
    Man

    • http://bclund.com/ bclund

      No date, buy back (cover) when you wish.

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  • RO

    Isn’t naked shorting more like advertizing the book for sale, selling it, then trying to buy it for less? No need for the friend to buy it … the bookstore will lend it to you if need be.

    If you can’t immediately get the book for less, then just wait until you can. Remember, the folks to whom you sold the book don’t really want delivery, just the promise.

    And because you don’t have to put up much, if any, real money, just the promise, you might have dozens of copies ‘sold’ (short) pocketing the profits.

    Of course, if you did this with clothing you might be sued for fraud, false advertizing, etc.

    Is that why you don’t naked short?

    • Nils

      You don’t naked short because your mother might think you are a pervert.

      • http://bclund.com/ bclund

        Hiyooooo……!!!!

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  • http://bclund.com/ bclund

    I never gamble….it’s like trading!

    Thanks for reading Judy.

  • Judy G

    A friend asked “How are you doing in the market?” I responded “I’ve made some money on the short side”
    His answer: I never do that… it’s like gambling.
    Duh.

  • http://bclund.com/ bclund

    A car could be standardized too.

    Like a black 68′ Charger for a black 68′ Charger.

    Thanks for reading.

  • http://gravatar.com/tk993 tk993

    I do the same thing only with cars. I like the idea of making it standard though, like harry potter book.