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Perhaps you've seen the movie "The Big Short" about the great recession at the end of the 2000s. There are great explanations in the film about a very complicated subject. Some people, who knew where to look, and who knew when to “Short” the market, got really, really rich!
But understand, “Shorting” the market is betting against the market, and over the course of the stock market's history, it has made terrific gains. But there have been great opportunities to ”Short” it as well.
Certified Financial planner Neil Vannoy explains in this week's Money Talks, “Shorting the Market” is all about timing.
"Short Selling is a way to make money when the price of a stock drops," explains Vannoy. "It involves borrowing shares you don't own from your brokerage firm, immediately selling them at the current market price, and trying to repurchase them later at a lower price. If you're successful, you get to keep the difference between the higher sales price and the lower buy price."
The transaction can be a complicated one, but Vannoy broke it down.
"Assume that XYZ stock is trading at $50 per share. You expect the price to drop, so you borrow 100 shares, which are immediately sold for a total of $5,000," Vannoy said. "Two weeks later, when the price of XYZ is at $42 per share, you purchase 100 shares to close out the position. Since you received $5,000 from selling the stock but only have to pay $4,200 to repurchase it, you profit $800 on the short sale. But trading fees and interest will reduce your actual return in the real world."
Just like betting against the ‘Pass Line’ at a craps table in Las Vegas, “Shorting the Market” is betting against the market and many investors have no inclination to do it!
"Short Selling is risky, speculative and most investors would be fine without it for several reasons," said Vannoy. "Although there are times when the market drops or trades within a limited range, the long-term trend for stocks is positive. Short selling is a bet against this upward trend."
So, you are not betting with the group, you are going against it, and if the stock rises instead of drops?
Well, Vannoy explains further how bad that will be.
“The price of the stock you sell might actually appreciate, and you will be responsible for purchasing shares to repay the loan no matter how high the price climbs," Vannoy explained. "Your brokerage firm has the right to redeem the borrowed shares at any time. This means that you could be forced to cover your position immediately, regardless of the price of the stock you sold short."
So, what was the greatest " “Short" of all time? Well, in 1992, George Soros shorted the British pound and reportedly made a profit of $1 billion. He sold billions of pounds during the days preceding the British government devaluing the pound sterling in September of that year. Much of it was on borrowed money. He's been rich ever since!
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