It is Too Cold for Shorts

Have you noticed, too? It has suddenly turned autumn. You can’t tell by the colour of the leaves on the trees yet, but it is quite a bit colder already. No weather for walking around in shorts. And yet a lot of people still do. You can find them in the stock market.

A short in the stock market? Yes. We get it when an investor has sold something he does not have. Is that possible, then? Yep. Don’t underestimate those investors. They can be very creative. Some of them even sell financial products that don’t even exist. But we will talk about that another time.

An investor who sells what he doesn’t have does so on the assumption that he can buy back what he sold later at a lower price. Then he makes a profit. It may go against the nature of most investors. After all, almost everyone who invests buys. We buy a share at 100 euros because we suspect it might rise to 120 or even 200 euros. 

But what if you think a share will fall? What if a share is trading at 100 euro and you expect it to fall to 80 euro? Then you can ‘short’. You sell at 100 euro and wait for it to fall. At 80 euro, you buy it back. The profit? 20 euros!

There are two problems with shorting. Problem 1: in principle, you cannot sell what you do not have. But there is a solution. You borrow the shares you want to sell from an investor who does have them. You then give those borrowed shares to the buyer. Later, when the shares have fallen in price, you buy them back and give those shares back to the person you borrowed them from. The shorter also pays a (small) fee to the lender of the shares. Problem solved!

Problem 2: You may think a share is falling, but that doesn’t make it fall. If the 100 euro share does not drop to 80 euro, but rises to 120, the shorter will ‘cut’. That means he does not want to see his losses increase further. I fear a lot of shorters will have to ‘cut’ in the coming days. What is by far the most popular short at the moment? Chinese stocks. And which stocks have risen sharply in the past two weeks? Chinese stocks. A lot of hedge funds and other investors assumed that Chinese stocks could only go down. But that trend has now been reversed. In just a few days, shorters have lost $7 billion on the rise in Chinese stocks. Own fault. It’s no weather to walk around in shorts.

This article was translated from Dutch and was originally published on Spaarvarkens.be.