JayDirex
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- Jan 5, 2019
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Alright fellow Authors. I know you've heard the term "Short selling, or Shorting" a stock on the market thrown around in speech. So, I'm going to write an explanation of shorting using an Iphone in place of a stock (because we all know what an Iphone is and it's value, approx $1000 US Dollars.)
Ok, Let's suppose I am Mr. Hedge-funder and I have information or a hunch that the price of a current Iphone is going to drop from $1000 to say $700 in one day. (it doesn't matter why I know the price will drop, I just know it will).
Step 1: The first thing I do is go to my buddy who has an Iphone and ask him to borrow it. (Yes, a hedge-funder can LITERALLY borrow a stock from an investor, but he will pay the investor interest for the time the stock (Iphone) is borrowed).
Step 2: So I (Mr. Hedgefunder) has borrowed this Iphone from one of my investor buddy. And the phone is worth $1000. So then I take that Iphone and I immediately SELL IT ON THE MARKET for $1000. (Yes, I have a sold a borrowed instrument.) Now I have $1000 in cash from that sale.
Step 3 -The SHORT: So I am standing here with my $1000 in cash when, lo and behold, the market for the Iphones begins to drop precipitously. And by close to the end of the business day, Iphones are only selling for $700 (as Mr. Hedge-funder predicted). So, before the market closes, the guy I sold the Iphone to comes back to me PISSED! and he's like
Buyer: "Hey man! I bought this Iphone from you for $1000 earlier today, but now it's only worth $700. WTF!!!?"
Me- Mr. Hedge-Funder: "Wow, that's rough, my man. But since I like you I'm going to help you. What I'll do is buy that Iphone BACK FROM YOU, but for $700, since that's the current market price now."
Buyer: "Fine! I'll take the loss. But at least I'll make some money back!"
Me: "Cool, so here's $700, and I will buy that Iphone back from you."
And that ^ my friends, is called a short sale, and Mr. Hedge funder sold the phone for $1000, and then bought it back for $700; netted $300 on that short sale.
Remember:
1. Mr. Hedge-funder borrowed an Iphone. Then sold that Iphone for $1000 on the market
2. The market price dropped on the phone to $700 by the end of day. So the guy he sold it to now wants to get rid of it. So Mr. Hedge-funder BUYS IT BACK for only $700
3. But don't forget. The phone is actually borrowed. So Mr. Hedge-funder must return the borrowed Iphone back to his buddy before the end of the day. And when he does, he pays the buddy $20 for the trouble of borrowing the Iphone (interest on the time the stock is borrowed).
4. Which means Mr. Hedgefunder made a profit of $280 by shorting the Iphone.
And that is what is called "Shorting" or "Short Selling"
now imagine this on a MASSIVE SCALE - three throusand Iphones borrowed, sold, and bought back. - Short sellers make monies.
***NOTE: This is a SUPER BASIC LAYMEN'S explanation. I'm not going to go into how the market is manipulated into creating the short in the first place. I'm just laying out the basic steps of 1. Borrowing a stock. 2. Selling that stock for a high price 3. Buying it back at a low price to. 4. The difference is the profit.
Ok, Let's suppose I am Mr. Hedge-funder and I have information or a hunch that the price of a current Iphone is going to drop from $1000 to say $700 in one day. (it doesn't matter why I know the price will drop, I just know it will).
Step 1: The first thing I do is go to my buddy who has an Iphone and ask him to borrow it. (Yes, a hedge-funder can LITERALLY borrow a stock from an investor, but he will pay the investor interest for the time the stock (Iphone) is borrowed).
Step 2: So I (Mr. Hedgefunder) has borrowed this Iphone from one of my investor buddy. And the phone is worth $1000. So then I take that Iphone and I immediately SELL IT ON THE MARKET for $1000. (Yes, I have a sold a borrowed instrument.) Now I have $1000 in cash from that sale.
Step 3 -The SHORT: So I am standing here with my $1000 in cash when, lo and behold, the market for the Iphones begins to drop precipitously. And by close to the end of the business day, Iphones are only selling for $700 (as Mr. Hedge-funder predicted). So, before the market closes, the guy I sold the Iphone to comes back to me PISSED! and he's like
Buyer: "Hey man! I bought this Iphone from you for $1000 earlier today, but now it's only worth $700. WTF!!!?"
Me- Mr. Hedge-Funder: "Wow, that's rough, my man. But since I like you I'm going to help you. What I'll do is buy that Iphone BACK FROM YOU, but for $700, since that's the current market price now."
Buyer: "Fine! I'll take the loss. But at least I'll make some money back!"
Me: "Cool, so here's $700, and I will buy that Iphone back from you."
And that ^ my friends, is called a short sale, and Mr. Hedge funder sold the phone for $1000, and then bought it back for $700; netted $300 on that short sale.
Remember:
1. Mr. Hedge-funder borrowed an Iphone. Then sold that Iphone for $1000 on the market
2. The market price dropped on the phone to $700 by the end of day. So the guy he sold it to now wants to get rid of it. So Mr. Hedge-funder BUYS IT BACK for only $700
3. But don't forget. The phone is actually borrowed. So Mr. Hedge-funder must return the borrowed Iphone back to his buddy before the end of the day. And when he does, he pays the buddy $20 for the trouble of borrowing the Iphone (interest on the time the stock is borrowed).
4. Which means Mr. Hedgefunder made a profit of $280 by shorting the Iphone.
And that is what is called "Shorting" or "Short Selling"
now imagine this on a MASSIVE SCALE - three throusand Iphones borrowed, sold, and bought back. - Short sellers make monies.
***NOTE: This is a SUPER BASIC LAYMEN'S explanation. I'm not going to go into how the market is manipulated into creating the short in the first place. I'm just laying out the basic steps of 1. Borrowing a stock. 2. Selling that stock for a high price 3. Buying it back at a low price to. 4. The difference is the profit.
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