#Business and #Economics ~ What is Short Selling

25 Oct

As always, this lesson is not intended to be professional advice. This is simply lesson material for ESL students in an introductory Economics and Finance class. Posted here for their use or for helping other students. 

Part #1 ~ Vocabulary

  • Short Sell (v.) ~ X borrows stock from a stock broker, sells the stock, buys it back, and then returns the stock to the stock broker. 卖空 – Mài kōng
  • Stockbroker (n.) ~ Someone who buys and sells stocks (a middleman – 中间人). 证券经纪人 – Zhèngquàn jīngjì rén
  • Shares (n.) When part of a company’s ownership is divided into equal portions, each portion is called a share. Each share gives the owner part of the ownership, profits, and a vote. A piece of the Stock.  – Gǔ
  • Loan (n.) ~ Money that A borrows from B and must eventually pay back. Often includes an extra “interest”息 fee.  – Dài
  • Stock price (n.) ~ The cost of purchasing one share (股of a company. 股价 – Gǔjià
  • Stock Market (n.) ~ A place (either a physical market or an online market) where buyers and sellers trade in company shares. 股市 – gǔ shì

Part #2 ~ What is Short Selling

Short selling is where:

  1. Step 1: You borrow 借 some shares 股份 of Company A from your broker (证券经纪人). Notice that you did NOT buy, so it is similar to a loan. You must pay the broker back the money for the stock later. 
  2. Step 2: You sell the stock to someone else. 
  3. Step 3: You buy the stock back again and give it back to the broker. 

Part #3 ~ Why or Why Not Short Sell?

If you short sell correctly and are successful, you can make a lot of money doing this. 

But if you want to make money, then the stock price 股价 must go down between Step 2 and Step 3. 

If the stock price 股价 goes up between Step 2 and Step 3, you will lose money.

If you buy long, you just use your own money to buy the stock. 

Part #4 ~ Examples 

Marilyn’s Flowers (ABCD) is selling their shares at $25 for one share. 

Michael believes that the price of ABCD’s shares is inflated (充气) and is too high right now. The shares are not worth that much money. He also believes the price is going todecrease in the future (usually very soon). 

Samuel believes that the price of ABCD’s shares is not going to decrease in the future. Instead, he believes that the price will increase.

EXAMPLE #1 (Buying Long)

Samuel goes to the Stock Market (股市) and uses his own money to buy one share for $25.

Situation A: Michael is right. Two days later, the stock price goes down to $10. 

  • Samuel’s Revenue: $10
  • Samuel’s Cost: $25
  • Samuel’s Profit: (-$15) Samuel lost his money.

*Notice that in this situation, the maximum amount of money Samuel can lost is $25. Even if the stock price 股价 falls to $0, Samuel will only lose $25. 

Situation B: Samuel is right. Two days later, the stock price goes up to $45.

  • Samuel’s Revenue: $45
  • Samuel’s Cost: $25
  • Samuel’s Profit $20

*Notice that in this situation, Samuel’s profit could go very high as long as the price keeps going up. It is better for Samuel if the price goes up and bad if the price goes down. But his only risk is $25.

EXAMPLE #2 (Short Selling)

Instead of using his own money, Michael goes to Thomas & Sons (his stockbroker) and borrows a share from them. He goes to the Stock Market (股市) and sells that share for $25. 

Situation A: Michael is right. Two days later, the stock price goes down to $10. Michael buys one share for $10 and gives it to Thomas & Sons to pay them back for what he borrowed. 

  • Michael’s Cost: $10. 
  • Michael’s Revenue: $25
  • Michael’s Profit: $15

Situation B: Samuel is right. Two days later, the stock price goes up to $45. Michael has to buy one share at $45 to give to Thomas & Sons to pay them back for what he borrowed.

  • Michael’s Cost: $45
  • Michael’s Revenue: $25
  • Michael’s Profit: (-$20) ~ Michael actually lost $20. 

*Notice that in this situation, Michael could lose a lot of money (far more than the $25 he earned. If the price keeps going up, he would lose more and more. For example, if the price goes up to $100, Michael will lose $75. The risk for Michael is more than the risk for Samuel. 

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