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Ask HN: Please explain short selling?

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Re: Ask HN: Please explain short selling?

#41

Post by cschneid »

Regarding who the shares are borrowed from, from my understanding, any client who signs a margin account agreement also signs something that says "sure, you can borrow my shares, and lend them to another person". Your account will never show it, and presumably there's no way to actually lose those shares (between insurance, and the margin allocated on the borrowers side).

As other people say "large institutional" investors most likely provide a nice pool of shares as well, which their agreements with the brokerage allow to be shared out.

Re: Ask HN: Please explain short selling?

#42

Post by fexl »

garethm wrote: post #17
fexl wrote: post #14

I'm a hedge fund accountant, and my software follows many thousands of trades including short sales. I know exactly how to account for these trades, but I have no idea what's really going on. As an accountant, all I see is that someone sold 1200 XYZ shares at $23.00 each, receiving a grand total of $27,600 cash. To simplify the example, I am not subtracting any commission there. Now the funny thing is, this account d…

The increase in supply is not caused by the final net position. It's in what you see when you look at the market. Suppose there are 100k shares issued. Some traders decide to naked short 50k. Actual holders of the shares say, "Oh crap. Half the company is for sale - better dump my shares while I still can." So they put up a total of 75k for sale. Now 50k of the 75k of actual shares need to be purchased by the people…

These are great examples, and your point is well taken.

The https://loom.cc/faq system avoids this sort of nonsense altogether. An asset type such as 2fcb2b81bb96bb51cec88edcb4b9a480 might represent a real underlying asset being traded, but only the true issuer of that asset could create new units of it.

Anyone desiring to sell that asset short would have to create a brand new distinct asset type such as 6b17a53d425dbb15f933b98ace93e587. This new asset type would represent just that one individual's liability to pay back the original asset. So the new asset type would in effect be a simple loan contract.

With this approach, the supply of the original asset type 2fcb2b81bb96bb51cec88edcb4b9a480 remains completely unaffected, and nobody needs to panic.

Re: Ask HN: Please explain short selling?

#43

Post by d2viant »

captaincrunch wrote: post #40
tarkin2 wrote: post #25

1. You borrow 100 shares from a broker. 2. You sell the 100 shares for, say, £1000 in total. 3. Prices for the share ideally go down. (You and others have been selling, after all) 4. You then buy 100 of the shares for, say, £900 in total 5. You then give the broker the 100 shares back 6. You've made £100 Normally the broker would charge a commission for the lending, hence his/her motivation. So if the commission were…

Thanks, this is exactly what I was looking for. I'm also glad, that I am not the only one confused about this type of trade. What if the lender decided to sell the stocks that he had lent out? Would the trade need to be closed for the short seller, or would he have to repay immediately and short sell a new lenders stock?

It depends on where the shares were borrowed from.

Either they were borrowed from the brokerage firms inventory or they were borrowed on margin from another clients account. If they're borrowed from the firms inventory, it's unlikely the short seller will be affected, because the firm will just have you borrow against different shares in their same pool of inventory. If they have no more left, they can borrow from another firm. In the very unlikely scenario that the firm decides to not hold ANY more shares of that company, then you may get called on the stock.

In the second scenario, if you're borrowing from another client, however, you may be at risk of getting a margin call -- in which case you would need to purchase the shares on the open market at their current price and return them to the lender.

Re: Ask HN: Please explain short selling?

#44

Post by cynicalkane »

lrm242 wrote: post #36
cynicalkane wrote: post #31

Earlier quoted context omitted.

The difference is, for the value investor, the selling part is optional. A company can repay its investors with dividends, liquidation (rare), being bought out... Often value investors end up selling to the market, but you have to break away from the mentality that buy low sell high is the point of "investing". If it is that way, then it's a zero-sum game, so why's it an important part of capitalism again?

Ignoring liquidation and acquisition, because they are rarely the goal of a value investor... Dividends do repay investors, but the price always adjusts ex-dividend. A value investor is not happy owning a declining asset even if the dividend pays at regular intervals. They always look for capital appreciation and will, whenever they deem appropriate, convert unrealized gains into realized. You seem to be referring to…

A value investor would not have bought a broad market index in 1999, where the P/E-10 was, IIRC, somewhere around 40!

I have to say I'm not particularly interested in discussing this with someone who thinks the classic value investing paradigm is comparable to buying and holding an index at the worst possible time.

Re: Ask HN: Please explain short selling?

#45

Post by clistctrl »

lrm242 wrote: post #26
mechanical_fish wrote: post #19

I just wrote a stock prediction system Oooh, a bankruptcy engine! The most prominent art form of our times. ;) You seem to understand that you've become dangerous to yourself and others. Be sure to keep listening to those thoughts. Just in case, you might want to get a tattoo: Past performance is not necessarily indicative of future results.

You do realize you're simply repeating commonly held bullshit wisdom, right?

As someone who has also tried to write one, I'll agree with his statement. Often following the technicals works very well. But if you know nothing about the fundamentals, one of these days you're going to end up making a very bad trade. I wrote my system so as to limit my losses. Which seems to work well. In my opinion the best way to trade is to make a decision to enter/exit the market based on fundamentals, and use technicals to decide how you do so.

Re: Ask HN: Please explain short selling?

#46

Post by captaincrunch »

d2viant wrote: post #43
captaincrunch wrote: post #40

Earlier quoted context omitted.

Thanks, this is exactly what I was looking for. I'm also glad, that I am not the only one confused about this type of trade. What if the lender decided to sell the stocks that he had lent out? Would the trade need to be closed for the short seller, or would he have to repay immediately and short sell a new lenders stock?

It depends on where the shares were borrowed from. Either they were borrowed from the brokerage firms inventory or they were borrowed on margin from another clients account. If they're borrowed from the firms inventory, it's unlikely the short seller will be affected, because the firm will just have you borrow against different shares in their same pool of inventory. If they have no more left, they can borrow from an…

So if you get called, you have to get them back to the lender...

Re: Ask HN: Please explain short selling?

#47

Post by fexl »

fexl wrote: post #42
garethm wrote: post #17

Earlier quoted context omitted.

The increase in supply is not caused by the final net position. It's in what you see when you look at the market. Suppose there are 100k shares issued. Some traders decide to naked short 50k. Actual holders of the shares say, "Oh crap. Half the company is for sale - better dump my shares while I still can." So they put up a total of 75k for sale. Now 50k of the 75k of actual shares need to be purchased by the people…

These are great examples, and your point is well taken. The https://loom.cc/faq system avoids this sort of nonsense altogether. An asset type such as 2fcb2b81bb96bb51cec88edcb4b9a480 might represent a real underlying asset being traded, but only the true issuer of that asset could create new units of it. Anyone desiring to sell that asset short would have to create a brand new distinct asset type such as 6b17a53d425d…

I believe this is roughly how shorts are handled on the Lima stock exchange, through the mechanism of "Operaciones del Reporte" -- a peer-to-peer lending system on the exchange. These loans are fully collateralized, keeping the risk extremely low.

Re: Ask HN: Please explain short selling?

#48

Post by danielsoneg »

garethm wrote: post #17
fexl wrote: post #14

I'm a hedge fund accountant, and my software follows many thousands of trades including short sales. I know exactly how to account for these trades, but I have no idea what's really going on. As an accountant, all I see is that someone sold 1200 XYZ shares at $23.00 each, receiving a grand total of $27,600 cash. To simplify the example, I am not subtracting any commission there. Now the funny thing is, this account d…

The increase in supply is not caused by the final net position. It's in what you see when you look at the market. Suppose there are 100k shares issued. Some traders decide to naked short 50k. Actual holders of the shares say, "Oh crap. Half the company is for sale - better dump my shares while I still can." So they put up a total of 75k for sale. Now 50k of the 75k of actual shares need to be purchased by the people…

Well, the problem is less that there are more shares of a company for sale than currently exist and more that it can generate high levels of unrealistic downward pressure on a stock. With a normal short sale, there is some balance between the long and short side - that is, you can only short so much before the longs start buying again and stop the downward price movement, and there are only so many people willing to lend stock to short. Once the supply is gone and the price is in balance, you can't continue to short the company and the downward price movement stops, theoretically having incorporated negative market sentiment.

With naked short sales, you're removing the supply restriction, making it possible to continue to pressure the stock downward beyond where it should go in a balanced market. This sort of pressure can cause a panic among investors in the company and become a self-fulfilling cycle - once a company's stock is pushed below a certain level, many investors will dump the stock, regardless of the fundamentals of the company. It's not a cheap maneuver, but it's potentially phenomenally profitable for the people committing the short, and it's totally devastating to the company under attack. It also doesn't represent balanced market sentiment, nor the actual value of the company, and the company can be forced to take dramatic measures due to circumstances for which it wasn't to blame. It's a potentially highly destructive practice and banned for a very good reason.

Re: Ask HN: Please explain short selling?

#50

Post by coreyrecvlohe »

Simply put, a short sale is borrowing a stock from an institution, and selling it on the market with an obligation to cover the sale (return the value of the stock back to the borrowed party).

Now if the price of the stock goes up after you sold it, depending on how wide the margin becomes, you can stay in the contract, but guarantee more cash to the provider so that they are confident you will be able to cover it the future.

If the stock goes down, you can close the contract and return the value of the sale back to the institution, and effectively pocket the retained cash value of the purchase from when you first sold the stock short; turning a profit from a decline in price.

Often times there are companies out there that are running on fumes, overvalued, or are partaking in fraud; short selling is a useful tool that can help the markets discover new information about possibly shaky institutions.

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