Short selling is something you will hear mentioned a lot if you like to watch any of the business TV channels or read any business-orientated magazine. Some people do get a bit confused by the idea of short selling, but it is not actually that difficult to understand.
What is Short Selling?
The great thing about short selling is that it is a way for people to profit when the price of a stock is actually falling. In fact, those who make their money from short-selling depend on the price falling. When thinking about the stock market most people would view it as buyers purchasing stock and hoping that the price of this stock will rise over time — short selling is more or less the complete opposite of this.
With short selling an individual borrows and asset and then sells this on at the current market value. They then depend on the value of this asset falling so that when they pay back the lender they will be paying less money. These people involved in short selling make their money by pocketing the difference between the amount they sell a stock for and the amount they later have to pay for it.
If the individual involved in short selling buys a lot of stock and starts selling it they can then cause the price to fall by their actions. This is because of the idea that scarcity increases demand but the opposite is also true. The more of the stock the short-seller sells the lower will be the value of this stock. In some instances the fact that they are selling so much can make other holders of the stock panic and they too start to sell their stock thus further lowering its worth. This can all means that when the short-seller goes to pay for the stock they have used it will be at a greatly reduced price.
Ethics of Short Selling
There are many concerns about the practice of short selling because there may be a risk that it leads to market crashes. There is also the worry that it is not very ethical because short sellers go after companies that look like they are in trouble and make the situation worse by devaluing their stock further. In the past some countries, like the UK, have banned the short selling of certain stock. Short sellers would claim that they are actually doing well by showing the real worth of companies.