Cocktail Chatter: Defining Short-Selling

Cocktail Chatter: Defining Short-Selling

Before the Great Recession, “short-selling” wasn’t a cocktail party phrase.

But now, the wires are abuzz with talk of hypocritical politicians. Sometimes, short-selling is revered as an act of prescience, but often it’s reviled as something that can harm the economy.

Short-selling might not sound sexy to you, but Ewan McGregor would disagree. From trying to beat the system to bringing down the most important bank in England, short-selling is kind of a big deal.

Really, though, what is it?

Short-Selling Is Betting That a Stock’s Value Will Decrease.

Here’s some lingo for you: When an investor “goes long” on a stock, she’s betting that her investment will gain value in the future. When she “shorts” a stock, she’s doing the exact opposite—hoping, in fact, that that investment will plummet in value.

Shorting Means Borrowing.

This is less confusing than it might sound. An investor will borrow shares of a stock and then sell those shares that he doesn’t really own. He’ll keep the profit, but eventually he’ll have to buy those shares back in order to return them. So, you might borrow a share from a broker and sell it for, say, $100. Months later, after the share price has dropped, you might buy back that share for $10 in order to return it to your lender. You’d have made a $90 profit. See the logic?

For the same reason, however, short-selling comes with infinite risk (after all, that stock could go up infinitely instead of decreasing as you predicted).

How Short-Selling Took Down the Bank Of England.

In 1992, hedge fund manager George Soros risked $10 billion on the theory that the British pound would drop in value. He was right, which brought him $2 billion in profit—$1 billion in just one night. This incident was later referred to as “breaking the Bank of England.”

Why Does Everyone Think It’s Evil?

Short-selling has been blamed for everything from the stock market crash of 1929 to the collapse of the seventeenth century Dutch tulip market. In 2008, the U.S. government placed restrictions on short-selling, which was seen as a factor responsible for the market volatility. The restrictions were designed to prevent short-selling from sending failing stocks into a total nosedive. Some people view short-selling as akin to rooting against the home team, since investors profit from a market collapse.

So, What About It?

Some of the biggest flack goes to the politicians who have criticized the practice of short-selling as exploitive, even while doing it themselves.

We don’t envy their positions, whether long or short.

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