Who’s selling your stock lesson makes investors aware that brokers loan your and other street form stock to high selling short sellers. They buy back when prices fall to profit after repaying the loan and costs.
Who’s selling your stock?
Short Story Shorting Stocks course, Lesson 7, answers the question, who’s selling your stock? At the end of the lesson, links to related content help you learn more.
What you learn:
Brokers increase their returns by loaning street form stock from inventory to short sellers. By understanding that is how short sellers find stock to sell, you can understand how brokers serve both buyers and sellers that sometimes have conflicting interests and needs. That gives you a deeper understanding of stock market operations. Knowing more about stock markets and investing helps you grow as an investor.
Going short means selling
what you don’t own
Investors that short a stock, profit by selling shares they don’t own. Without your knowledge, a short seller may have borrowed stock that you own. The loan comes from your stockbroker’s inventory which includes the stock you hold.
In lesson 1 of this course we used borrowing sugar to help understand the short seller’s need to find an inventory to borrow. That your stock can be loaned by your broker without any notice to you surprises many new investors. As long as the stock is in the street name, brokers hold it in a common inventory with all other shares.
For a fee, those shares are made available to borrowers. While short selling profits can be sweet, the behavior part of the process surprises many new investors. Loaning a friend or neighbor a sweet ingredient seems a little bitter when it turns to borrowing stock to sell. You could feel put out should you learn ‘your’ sugar or stock was sold at a profit but that you get back now lower priced stock but none of that sweet profit or any of the fees charged by the broker.
The only consequence of not returning the sweet loan would be a sour taste. Missing out on any profit may be legitimate, but we can understand someone being annoyed, jealous or envious.
In the market all participants seek profit from their actions and assets. No transaction happens for any other reason. Each asset held or move made returns profit or loss. Each and every deal made must be settled by both parties. Selling short is simply one of those possible transactions.
Mad about shorting
Selling short or even discussing shorting a stock can raise the blood pressure of some people. Some can get quite mad and suggest shorts are questionable, unfair, illegal, unethical or immoral. Some even make a great deal of noise leaping onto their moral high horse to gallop off in several directions at once!
Weathering the trend
To avoid any horse-riding accidents or embarrassment, using an analogy can give a novice a better understanding of shorting. Consider that you are setting up a business to make bets on the weather. Your weather betting business places and accepts bets on future daytime high temperatures.
As sure as spring follows winter, betting that some weeks into the future there will be higher temperatures works well for half the year. But only for half the year, and only if you are not at the equator, of course.
Temperatures trend higher and lower in a predictable and known annual pattern. During the other six months the temperature trend falls. There is no questionable, unfair, illegal, unethical or immoral behavior. Just the facts. The weather repeats known and predictable annual trends.
Betting up or down with the trend, will always be the most sensible, more probable and certainly more profitable move. Ignoring any permit issues, your weather bookie scheme raises no questions of unfair, illegal, unethical or immoral behavior.
Investing black sheep
Rather than betting on the weather, short sellers bet that a stock price will be lower in the future. Although selling borrowed stock can turn heads and raise eyebrows, it remains perfectly legitimate. Still, short sellers are seen as black sheep investors.
Like an odorous flock of unwelcome visitors barging into a private club lounge, short selling disrupts the normal routine. A community of dealers and investors profiting from a rising market can get upset when the musky invaders arrive.
Such disruptive actions cause howls of protest. Most howls and moral outrage come from management of the targeted company. Additionally, those invested in the company and dealers associated with the target can add voices to the protest.
Howls from targeted companies and managements can be understandable. After all, short selling publicly and loudly says the targeted company may release imminent bad news, is overvalued or worse, a poor performer, fraud or run by bad managers.
Public accusations of bad management certainly get reactions. Short sellers get painted as disruptive, evil and unwelcome interlopers. They get accused of hoping to steal shareholder value. At times, the back and forth public accusations can seem very much like a political campaign.
The battles can be entertaining and very nasty. As in political or legal fights, facts argued and leaked can be true, fiction, obscured, spun or obliterated. Major short selling battles almost always involve legal maneuvers and court action.
As in any political fight, only the public perception matters. The market immediately reflects the current investor perception of the company worth. Shorts want to see selling pressure drive share prices down. Management and long investors want prices to hold or rise.
The short’s profitable plight
The shorts have the plight of being the unpopular kid on the playground that cries, “Wolf!” Although selling short is not illegal, unethical or immoral, should the bad news wolf actually come, it can be very profitable to have a short position.
Justified or not, the short seller’s target may be more than annoyed at the alarm being raised. When the shorts are right, the bad news becomes known. In panic, shareholders sell and the stock price plunges.
At that point unhappy stockholders and sellers can suffer great losses. The short player then profitably buys back stock at the lower prices. That covers their short position and locks in their profit. All the moral high horses quietly go away.
Question Answered!
Knowing that brokers increase their returns by loaning street form stock from inventory to short sellers helps us realize our stock may get loaned. By having knowledge of how brokers serve multiple clients with sometimes conflicting needs to produce stock for short selling gives you deeper insight to stock market operations. That helps your growth as an investor.
Lesson takeaways,
Who’s selling your stock?
Who’s selling your stock lesson makes investors aware that brokers loan your and other street form stock to high selling short sellers. They buy back when prices fall to profit after repaying the loan and costs.
- Short sellers must find stock they do not own to sell.
- Brokers with inventory will loan shares to short sellers.
- Short sellers often make the most unpopular stock market people’s list.
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Comments and questions welcome
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Short story shorting stocks:
Short selling stock explained Lesson 1
Short selling improves markets Lesson 2
Short selling improves companies Lesson 3
9 Short seller facts align Lesson 4
Making money selling short Lesson 5
Shorting stocks has risks Lesson 6
Who’s selling your stock? Lesson 7
Short seller skill sophistication knowledge Lesson 8
Short seller cost control Lesson 9
Short selling has rules Lesson 10
Next lesson 8: Short seller skill sophistication knowledge
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