The last few weeks have gotten people all talkative and excited. Primarily its debating between people who are interested in buying stocks low and people who are unloading now and… Well, buying stocks LOWER.
After watching this unfold for the last few weeks (and contributing to some of it myself, fufufu) – I noticed something interesting.
There’s been little to nothing written about shorting the market.
It’s interesting, because movies like The Big Short were made during times of Financial Crisis. I think the majority of financial media has branded it prematurely, but it’s still unusual that no one has talked about it.
If you’re reading this for the first time and have no idea what I’m talking about – what’s Shorting? ‘Shorting’ is how you make money. Right here – right now.
Short Selling [A Narrative]
Once upon a time, my friend Keith would spend a non-stop amount of time bragging about his new Rolex that was worth $15,000. His watch wasn’t really the type to increase in value, but he talked nonstop about how much it was worth.
Annoyed, I saw an opportunity to profit off that.
I borrowed his watch for 30 days, which he charged me $10 a day for. Pretty harsh, but I knew it would be worth it.
I sold his watch immediately, making $15,000.
Within 30 days, the valuation of that watch dropped from $15,000 to $12,000.
I was obligated to return the watch to Keith, so I bought the exact same type of watch online, spending $12,000 - and returned it to him, as promised. There was no difference in the watch – only the value, which had declined by 20%. Still, it meant little to me.
All in all, I...
a) Sold the watch, making $15,000
b) Bought the watch back, losing $12,000
c) Paid Keith $300 for the time which I borrowed the watch for
d) Profit = $15,000 - $12,000 - $300 = $2700.
My net profit was $2,700 for this entire process.
You have to understand the implications of what I just described. During this time, I made $2700 – where I owned nothing, paid nothing and made money from nothing.
This – as crazy as it sounds, is shorting.
At the most basic level, short selling is making a prediction that a stock will go down rather than up – and acting on it.
By borrowing shares of a stock [typically from a broker] you do not own and selling it at the current market price, you can re-buy those shares at a lower price in the future, and return those borrowed shares to the lender.
You profit off the difference in those prices, which is how you make money from shorting.
Successful Shorting Cases - Conn’s, Inc. (CONN) (2016)
The example above was obviously a fictitious, metaphorical example – (obviously, I don’t have any friends that irritating. I think.)
… But this particular case wasn’t, which is what I based the scenario above on.
Conn Inc, a large furniture and appliance company – was loaning money to its customers to buy its products.
By looking at the balance sheets as well as further analysis of the company, it was noted that Conn was giving out these loans with limited to no credit rating checks or background checks.
The number of loans lasting more than 2 months was increasing gradually and set to increase further, while on Conn’s end – they began to offer interest repayments alone without capital repayment, which made the company less and less successful when they couldn’t translate it into business.
The writer of this article made a 21% return on the stock by shorting it in a slightly over a month.
If he had discovered it months earlier, he could have made well over 60% across a 6-month period.
If you looked at the above and got super excited because of how applicable you feel it is to you, I suggest you keep reading.
Let’s look at the story I listed above for you. The money made only became realized because I was completely right about my investment decision.
What if I had been wrong?
If I had borrowed the watch, and the value of the watch appreciated in the 30 days to $18,000, this is what would have happened instead:
a) Sold the watch, making $15,000
b) Bought the watch back, losing $18,000
c) Paid Keith $300 for the time which I borrowed the watch for.
I would have lost $3300 instead of gaining $2700 – had the market moved proportionately in the opposite of what I had hoped for. As you can see clearly, $3300 is not $2700.
Tesla, the most shorted stock in the world – is a pretty classic case of shorting gone horribly wrong. Tens of thousands have lost hundreds of millions of dollars in trying to short Tesla since 2017.
Overall, Shorting is a pretty exciting (trading) option.
You’re able to make money in the midst of when people are losing money, especially when people are selling off like crazy. Anyone can make money by buying when prices are low eventually, but not everyone can make money WHILE people are losing money.
Much like value investing, you also get a pretty good sense of accomplishment when your due diligence and analytical decision making pays off in a big way, except that you make profits even faster compared to years of long-term investing.
Of course, if you’re wrong, it can go horribly wrong. It is not uncommon for poor investors – or speculative gamblers, essentially – to increase the duration of their borrowing just to cover their losses if they continue to believe they are right.
A proportional loss is already significantly more than a proportional gain – imagine if you’re wrong in a far worse manner than you imagined. Buying back the watch for $30,000 instead of $15,000, for example, would result in a 100% loss plus the cost of borrowing. You could lose far, far more than you bargained for.
All in all, it would be advisable for you to speak to an Investment Specialist for a second opinion before engaging in such a high risk, high return activity.
You will also want to figure out how to best utilize your gains when prices are low, which I would love to help you with.
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Money Maverick is a Licensed Financial Consultant with MAS, who specializes in Investments and Critical Illness Insurance.
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