forcing the price down to get the stock cheaper.
Short Selling Explanation
Imagine that the market for stamp collecting is really hot. You have a friend that has a large collection of very rare stamps. Sure, you can go on Ebay and purchase these stamps. But you do not want to buy them since you expect the market to drop. Buying and selling later would create a net loss. You want to sell your friends stamps for him and replace them later when prices drop.
You approach your friend and ask, “I have a proposition for you. I want to trade your stamp collection. If at any time you want your stamps back, I swear that I will go out and buy the identical stamps and replace every last one. This is a no risk situation for you. In fact, I will even pay you a small amount for loaning me your stamps.” You friend thinks about this for a minute and then agrees, provided you draw up a binding agreement. It is a winning situation for him since his collection usually just sits in a vault and gathers dust. Now you have a commodity to trade with. You are not the rightful owner or the stamps, but you merely loaned them with a promise to give them back later.
Next you hit the collector shops and stamp clubs. You sell the rare stamp collection for the market price. The money you receive from the trade is put in the bank where it collects interest. You can use the interest to pay your friend the small stipend for borrowing his collection. Then you wait, and wait. You hope and pray that the prices of stamps go down in price over time. If they do, you will go out and repurchase the exact same stamps for a lower price. You keep the net difference and return the collection to him. If prices go up, at some point you will need to dip into your own savings and repurchase the stamp collection at a loss before giving them back to the rightful owner, your friend. Thirdly, your friend might ask for the stamp collection at any time, thus you will need to repurchase them at whatever the market value is.
Add to My Watchlist
What is My Watchlist?