Many spectators to the trading game are fascinated when they first learn of selling stock short. The reason for the excitement is that shorting elmo opens up a whole new world of opportunity.
The lion’s share of the public has been indoctrinated with the philosophy of buy and hold. With such an approach the only way to score profits is if the stock market rises in value. And so, for the majority of people a climbing stock market becomes a necessity in order to make money. Rising prices mete out pleasure while falling prices deliver pain.
With such a narrow, one-sided view of the markets, buy low, sell high becomes the only game in town.
The beauty of selling short is that it allows us to embrace the buy low, sell high mantra, only in reverse – sell high, buy low.
It’s possible to borrow shares of stock from your broker to sell into the marketplace at a high price in hopes that you can buy it back later at a low price and pocket the difference.
See if the following personal story of the Tickle Me Elmo craze doesn’t shed light on selling short.
It was 1996 and the holiday shopping season was fast approaching. That year the must-have toy was Tickle Me Elmo. Remember the fuzzy red doll that would giggle and shake when tickled? I certainly do. My dad, ever the opportunist, would drag me around with him from store to store in search of the coveted toy so we could scalp him and make a quick buck.
I can’t remember how many dolls we ended up getting our hands on, but as soon as we were lucky enough to acquire a few we posted “for sale” signs at the most prominent bulletin boards around town. The Internet was in its early stages back then and eBay had just been founded the year prior so we marketed it on the up-and-coming auction site as well.
Suffice it to say, my Pops was able to sell Elmo for a hefty premium over the $28.99 we had to shell out in stores. I won’t bore you with the economics of the Tickle Me Elmo craze, but let’s just say demand far outstripped supply, temporarily driving prices for Elmo through the roof.
Here’s where the shorting application comes in.
Suppose in the midst of the mania you, like my dad, wanted to sell these outrageously overpriced Tickle Me Elmo dolls to the clamoring masses but weren’t able to find one. That is to say, you wanted to sell high but weren’t able to find little ol’ Elmo anywhere to buy low first.
Lucky for you, however, your friend has a few Tickle Me Elmo dolls he wouldn’t mind letting you borrow as long as you give them back some time in the future. So here’s the plan.
- Borrow Tickle Me Elmo from your friend.
- Sell him to the highest bidder at a ridiculously rich price.
- Wait for the holiday hubbub to subside and then go buy Elmo at the store for $28.99 once he finally becomes available.
- Return Tickle Me Elmo to your friend.
Welcome to the world of short selling.
You can do the exact same thing with a stock you believe is going to fall in value. Borrow shares from your broker, sell them at the presumably high price in the marketplace, then wait for prices to fall and buy the stock back.
That’s shorting in a nutshell.
- Jonas Taylor is a financial expert and experienced writer with a focus on finance news, accounting software, and related topics. He has a talent for explaining complex financial concepts in an accessible way and has published high-quality content in various publications. He is dedicated to delivering valuable information to readers, staying up-to-date with financial news and trends, and sharing his expertise with others.