Today was daddy-daughter day, so I didn’t do any trading. Instead I thought I would help with a problem that often comes up for traders, how to explain short selling to civilians.
Over the last few months, whenever I am asked at a social function what I do, and I respond “I trade stocks”, I get that “look” that ranges from pity to Schadenfreude, followed by something akin to them saying “things must be pretty tough, huh?” I of course respond that I am doing fine, because I can make money when the market moves down by……………
SHORTING…..!!!! (insert glazed look in conversationalist’s eyes).
My mother actually thinks that am doing something illegal when I tell her I can make money when a stock goes down. Personally, I never had an issue with the concept of shorting, which is maybe why I am a trader, but for others who do, I have developed a simple way to explain it. It goes like this…..
A share of stock is standardized, just like a book, meaning each share of IBM is the same, just like every copy of Harry Potter and the Deathly Hallows, on the shelf at the local bookstore is the same. So let’s say your best friend just bought a brand new copy of Harry Potter, and the moment he brought it home you asked him to borrow it. Now that you have borrowed it from him, you owe him back one copy of Harry Potter. So you take the copy he loaned you, and you sell it. Maybe you sell it on Ebay, maybe at a garage sale, maybe to an individual, it doesn’t really matter. You get $25.00 for the book when you sell it. Now you still owe your friend one copy of Harry Potter, so you order a copy on-line, at a discount book wholesaler. That copy only costs you $19.95. The book arrives, and you return it to your friend, and keep the difference between what you sold it for ($25.00), and what you bought it back for ($19.95). You have thus made money by selling something you did not own, and then buying it back for (and replacing it) for less that you sold it for.
Short selling is the same concept, you just replace a share of stock of XYZ company, for the copy of the Harry Potter book. In the above example, the venue you sell the book in could be various, but with the stock, it is the open market. Now if you were unable to buy the book back for the $25.00 or less that you sold it for, you would have had to cover the difference out of your own pocket, and thus lost money. The same would go for the stock example as well.
If they don’t understand the concept of short selling after this explanation, then they never will.
