Short Selling, Market Manipulation?

Just to help some, probably most, of you understand a term that gets used a lot in the news about the stock market, this article will deal with "short selling." Now short selling doesn't have to be just in the stock market, as it is in real estate, and it can be used pretty much for any asset, as long as the actual owner is willing to loan you whatever the asset and agree to its replacement. I will exaggerate a bit here in my example to make a point, as most short selling in stocks is not done in such small amounts, but rather in the thousands, or tens of thousands of shares, and most often prices don't move in such dramatic fashion.

When you "short" something, in this example, stocks, you don't actually own it, you borrow it. Now you might wonder how you can sell something you don't own, but remember, this is the world of finance and investment, where the big boys (and in more recent times, big girls, too) make the rules to suit themselves. I would dare say most people think of stocks or other assets having to gain in value for the owner to make money, but not in the financial world, where they have tailored transactions to cash in on items that LOSE value.

So here is my example: You borrow 100 shares of company "XYZ." At the time you borrow the shares, each share is worth $10.00. You sell the 100 shares and so now you have $1000 (100 x $10). It is important to remember, you did NOT borrow $1000, you borrowed 100 shares of company XYZ. The next day company XYZ reports earnings way below what were anticipated; the price of a share falls to $5.00. You now buy 100 shares at $5.00 for a total of $500 to cover; that is, pay back the 100 shares you borrowed. So $1000 - $500=$500 profit for you. Understand, there are fees associated with borrowing shares and then the selling and buying of shares, but I've left that out to keep the basic principle as simple as possible. Understand, there is risk involved, as if XYZ reports higher profits, the stock will then cost you more to buy and you will lose money. The basic principle is, you thought XYZ was overvalued at $10 a share and that the company's earning would not support that price, so you went through the above process, but what if you had a "tip" from someone inside the company that profits were down? That would give you an advantage, and that's why insider trading is illegal; not that illegality has stopped it. Short selling has also been cited by some as contributing to market instability and market crashes, as "borrowers" need that particular stock to decline to make money, leaving open the possibility of rumors to move stocks lower. Again remember, typically these transactions aren't about $500, like in my example, but they are more about hundreds of thousands or millions of dollars at a time. When you talk about that kind of money, LOOK OUT! Some countries have strict rules about short selling, especially about short selling stocks from banking or other financial companies.

Back around the time of the Wall Street Crash of 1929, which heralded the Great Depression, there was one company executive (I can't recall his name or which company was involved) who shorted tens of thousands of company shares for millions in profits for himself (remember, even ONE million dollars back then was like many, many millions in today's money). Such things helped bring some regulation to all of the nonsense, although I'm sure the millionaires who had benefited from the original process whined all the way to the bank, which they likely owned anyway.
 
WORD HISTORY:
Short-This is closely related to "shirt" and "skirt;" the literal meanings of which are, "short garments." It goes back to Indo European "sker," which meant "to cut." This gave its Old Germanic offspring "skurtaz," which meant "short," from the notion of something being "cut off." This gave Old English (Anglo-Saxon) "scort," meaning "short," which then became "schort," before the modern version. Over time many of the other Germanic languages came to use forms of a relative of "short;" that being "curt," as their word for "short," although they also kept forms for the related "shirt/skirt." German once had "scurz," but today only Icelandic (from what I can determine) has words used with the same general meaning as the English word, and Icelandic has both "skortur" (deficiency, shortage) and "skort" (to lack, be short of).