Short Selling

What is short selling?

short selling, is basically, selling stocks you dont have, and buying them back, within a short period. anticipating a rapid drop (before the transaction is settled, usually 3 days)



lets say, a stock is worth $10 a professional investor thinks the stock wil drop further. so he will sell 1000 $10 shares (worth $10'000 he does not have. this will make him go short 1000 stocks. (like being in debt)
2 days later, the stock has indeed dropped, to $90, the investor decides to buy back the stocks he sold before the stockexhange forces him to cough up the shares he doesnt have. he buys 1000 stocks at $9'000 and closes his short position.
net profit: $10'000 - $9'000 = $1'000
so where does this money come from? from the investor that bought the stocks from this professional investor. now why is this unfair? because not everyone can have a short position, only institutional investors can. so instotutionals unrightfully take the money from private investors.

Then why the difference in the terms 'naked short selling' and 'short selling'?
being naked means you have no clothes on. Likewise a naked short means selling shares without having any of those shares, a true short sale. On the other hand you could own the shares but sell them withe intention of buying them back if/when they go down. This would be a covered short, which is not really a short.

Why does naked short selling drive the market down?
Two ways:



1. increases supply. w.o. naked shorting, you can only short as many shares as are already issued by the company. by naked shorting, there is no limit.


2. creates an artificial market flurry of selling activity. most people who own the stock of most companies, don't want to sell just because the market moved a little. but naked shorters are by definition speculators, so there is not only an increase in the number of THINGs that could be sold (stok plus naked shorsell orders) but an increase in the actual number of SALES. This is a subtle distinction.

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