Occasionally, at a social function or while scrounging through the dumpster in back of Arby’s, I’m asked, “What do you do for a living?”
Sometimes I’ll just say I work in an ice cream shop or huck a handful of soggy curly fries at them. But if pressed, I’ll cop to trading stocks for a living.
This revelation prompts a range of looks – from excitement to Schadenfreude – depending on how the market is behaving. If it’s in a downtrend, I usually get a pitying look and something like “wow, it must be tough for you, huh?”
My response? “Well, you can make money shorting stocks.”
(insert glazed look in conversationalist’s eyes).
My mother thinks I’m describing an illegal activity when I tell her you can make money shorting stocks. She’s convinced that it’s an evil endeavor created by Satan and/or Hitler.
Personally, I’ve never had an issue with the concept of shorting. But for others who don’t understand the concept, I’ve 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 Blue-ray, meaning every share of Apple is the same as every other share of Apple, just like every Blue-ray of Harry Potter and the Deathly Hallows is the same as every other.
Let’s say your best friend just bought a brand new copy of Harry Potter and brings it over to show you. The first thing you should do is ask yourself is why you have a 13yr old as your best friend, but after that, let’s say you immediately ask to borrow the DVD before it’s even unwrapped.
At some point you will have to return it to your friend – I mean, not really since you can probably beat up a 13yr old – but assuming you’re a decent person, you’ll eventually give it back.
Now, let’s say that you take the copy you borrowed and sell it. Maybe you sell it on Ebay, or Craigslist, or on a street corner, it doesn’t matter where, but you get $25.00 when you do.
However, you still owe your friend one copy of Harry Potter, so you order a copy on-line from a discount DVD liquidator that only costs you $19.95.
When the DVD arrives 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). Thus you’ve made money by selling something you did not own and then buying it back (and replacing it) for less than 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 DVD.
In the above example, the venue where you sell the DVD could be anywhere, but with stocks, it’s the open market. If you were unable to buy the DVD 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 making it a money-losing trade.
Or you could just tell your friend you lost the DVD and say “what the f**k you gonna do about it punk?”
The same concept applies for the stock market example as well (minus the “punk” part).