Friday, August 15, 2014

George Soros is "short selling" the US market. A quick Lesson on "Short Selling"

There is an article in Business Insider today on Billionaire George Soros and how he is "short selling" a collection of stocks in the US market.

Most people buy stock in a company with the expectation the price will increase, or appreciate, in value. This is called "going long" on a stock.  Buy Low, Sell High.

However, there is a stock trading technique call "going SHORT" on a stock. Also known as "Short Selling". This means you anticipate the price of the stock will go DOWN.  Buy High, Sell Low. The defintion of "Buy" in short selling is misleading at best.  But it is a way of making money when the price of a stock goes down.

Go here for a more technical explanation of Short Selling.  Below I give a most elementary, non-technical explanation of how this works.  If you are not familar with the trading technique it might help you when you start looking into the complexities of short selling.  Gotta walk before you can run!

Short Selling a stock:
I borrow 100 shares of stock you own in "XYZ Inc". Right now those shares are worth $10.00 each.  Let's say I pay you $50.00 up front as a fee to do so AND I PROMISE to return those shares to you whenever you want them back. 
I take those shares and immediately turn around and sell them. I now have $1,000 in my bank account. 
Let's say the stock price goes down to $5.00. You freak out and want your shares back so you can sell them and take your losses. You come to me and demand your 100 shares back. 
Well, I do not have them anymore!  So, I have to go out and buy 100 shares at $5.00 per share. I am sure there will be plenty of sellers as the stock price decreases.  I need $500.00 to do so. Remember, I have $1,000 in my account for the original sale at $10.00 per share. 
I write a check out of this account for $500.00 to buy 100 shares. I still have $500.00 remaining in my account.  MAGIC!!! (minus the $50 I paid you up front I "clear" $450.00 in the end and adding the $50 fee I paid you, you lose a total of $450.00).
Not bad, eh?

You might be wondering: "What if the price did not go down but went up instead?"

Then I am in a bit of trouble.  My prediction that the price would decrease did not pan out.

If the price went up to $15.00 per share then the total value of the 100 shares is $1,500. You want your 100 shares back so you can take the profit!

I now MUST go out and purchase those 100 shares for $15.00 each.  I only have $1,000 in my account from the original transaction so I have to deposit another $500.00 in order for my check to you to clear.

I lose $500.00  (plus the $50 fee) and you gain $500.00 (plus the $50 dollar fee) on the investment.

Crazy system, right?

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