If you have been on social media or been paying attention to stock market news, you’re probably wondering about what it means to be shorting a stock at this point. I’m going to try to explain this concept in the post so you too can become an expert in shorting a stock.
I think we can all understand the mechanics of buying a stock. We buy shares of a particular stock (of a company) in the anticipation and hope that it will increase in value. Based off of your trading plan, you then determine what kind of return you are looking and under what conditions you would sell your stock in a best and worst case scenario.
Now, when we flip it to shorting a stock, many people get confused so I am going to try to simplify this concept for you. When shorting a stock, a position is opened by borrowing shares of a stock that the investor believes will decrease in value by a certain future date. The investor sells these borrowed shares to buyers willing to buy at today’s price for those same shares. The investor is betting that the price will continue to go down and they will be able to purchase them back at a lower price. In exchange for borrowing these shares, the investor also has to pay some fee or interest until the shares are returned to where they were borrowed from.
You may be thinking that is an absurd scenario, who would do that in real life? Let me give you a couple of analogies:
Payday Loans – we’ve all seen the ads or places where they advertise that you can cash in your future paycheck to get money NOW! So, if you are getting a $1000 paycheck in 2 weeks, they will give you $900 now and you will sign over your paycheck in 2 weeks. So, not quite the same as shorting a stock but an example of where somebody would give you an amount and charge interest/fee so you can get the money now.
Perhaps, a better scenario is this: Let’s say your friend has two PS5 and lends you one of them so that you can play a game together in 2 weeks. You being the hustler, decide to sell that borrowed PS5 because you think you will be able to get a replacement PS5 for cheaper over the next 2 weeks. So, you find someone to buy this PS5 for $600 (retail: $500) and go on your way. Over the next week, you start to notice that all of the stores are sold out and PS5s are nowhere to be found. Even resellers on Ebay and Facebook are asking $1000 for a PS5. You are now experiencing a shorting situation.
Just imagine now if your friend was charging your money for every day that he lent you the PS5. This is what we are seeing with some hedge funds and Gamestop stock in the marketplace this week.
Keep reading our blog for more info but hopefully you have a better idea of what it means to be shorting a stock now.
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