What is Short Selling?
/At this point, you’ve probably heard the news about how a large group of social media users have banded together to hurt the short sellers of GameStop and other stocks. You might be wondering what short selling is, and why someone would do that in the first place.
Short selling is a complex and extremely risky tactic used to bet against a stock when someone (usually a hedge fund manager or a sophisticated investor) anticipates it’s going to fall in price. It’s essentially an attempt to time the market. In the simplest of terms, a stock trader borrows shares of the stock, usually from a broker, and sells them at the current price. They then wait for the stock price to fall and buy the shares back at the lower price to return the borrowed shares and their bet pays off with a profit. At least, that’s the goal.
If the person who sold the stock short is wrong, and the price goes up, they are forced to buy back at a higher price, thus losing money. This is what has happened recently, in which Reddit users have encouraged their followers to buy GameStop stock, driving the price up and forcing the hedge fund managers to buy back at a higher price, losing millions on their original bets. There is an unlimited amount of risk associated with this type of trading because there is no limit to how high the price of the stock can go if the stock goes up instead of down (as expected).
Due to the risk involved, I don’t recommend you try this strategy on your own, either on the buying or the selling side. Eventually, the bubble will burst, especially when a company’s fundamentals (which determine the financial health of a company) don’t support a higher stock price. Sooner or later, the social media followers that have pushed the price up will sell their positions in the stock, and the price will naturally come back down. This could cause many of the inexperienced stockholders to lose their entire nvestment. The moral of this story is, don’t try to time the market.
- Margaret Gooley, CFP®, Worley Erhart-Graves Financial Advisors
