Short selling stocks - Risky business?

To put it simply, short sellers make money when the share price goes down.  It goes a bit like this.  Let’s say you own 1000 BHP shares and the current share price is $40 (total value = $40,000).

Because I am a risk taker, I will take on the role of short seller.   I contact my broker who gives me, I mean borrow for a fee, your shares and then I immediately sell them on the stock exchange.    I have pocketed $40,000.

Remember, I am a short seller and hoping (gambling) that the share price will go down.   Surprise, surprise I am right!  The BHP share price does in fact go down to $30.   Yippee.  This means that I can now buy 1000 shares at $30 each and only need to outlay $30,000 to buy them back.

I return  your 1000 BHP shares.   There you go, I have made a quick $10,000.   If the price went up to $50 each, rather than down to $30 each, I am in big trouble.  I have lost $10,000 (plus the fee).

Plenty of debate raging at the moment about short selling and lots of finger pointing that it has been the major cause of the current financial crisis.  I do not accept it is as simple as that.  No doubt lack of regulation in the US has been a factor, but I believe a huge contributor to this ‘once in a lifetime’ crisis has been our debt binge and it has come back to bite us with a vengeance.

Who knows how long it will take to recover from this hangover.     Looks like we have to get back to the basics - living within our means.

If you want to know more about short selling, the attached document by Investopedia is quite good and fairly easy to understand.

investopedia-basics-of-short-selling-sept-082

Cheers

Josie Kay

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