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The Best Explanation on How Shorting the Stock Market Works

How Hedge Funds Make Billions Shorting Stocks...
Shorting Stock Explanation

I Love Making Money Staff & writers

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I have never seen a simple explanation of how shorting the stock market works, and how billionaires profit billions when they short stocks. Our recent TikTok is one of the best explanations I have seen on the internet. Take a look here:

Shorting is when an investor borrows shares and immediately sells them, hoping they can scoop them up later at a lower price, return the borrowed shares and pocket the difference.

@thebusinesskid

How to Lose Five Billion Dollars…

♬ original sound – The Business Kid

How Do Hedge Funds Profit from Shorting Stocks

In this example, you have Citron and Melvin who borrow shares from online brokerages and sell to the marketplace, you. Citron and Melvin think the stock will drop so they’ll sell now and wait for the price to drop. When the price drops, they buy back the shares at a lower price and return the shares to the brokerage pocketing the difference between the purchase and sale price.

What is Shorting in Trading

A short is when you borrow a stock from a broker and sell it immediately at its current price. Then, you hope the stock’s price falls such that you can buy the stock back at a lower price and return the shares you borrowed to your broker, but keeping the difference.

Shorting Example

Let’s say I want to short company XYZ, which has a current share price of $100. I borrow 10 million shares from an online brokerage firm and sell it at $100.

10,000,000 shares
x $100
$1,000,000,000 total

That’s 1 billion dollars I bring in. Let’s say the price of XYC drops to $50. I now decide to cover my short position and buy 10 million shares at $50.

10,000,000 shares
x $50
$500,000,000 total

I return the original 10 million shares that I borrow from the broker and pocket the difference. In this case, I pocket $500 million dollars. You can use our stock return calculator to calculate percentage gained.

How Could I Lose Money in This Example

A few weeks ago, a redditor on the forum r/wallstreetbets noticed that a hedge fund had taken a massive amount of short trades against GameStop. They convinced everyone on the Reddit thread to join forces and buy as much GameStop as possible. This made the price rise.

Remember, the hedge fund predicts the price will go down and then, they buy at the lower price to cover their short and pocket the difference. Wind of the GameStop short squeeze went viral online and everyone started buying GME. That caused the price to rise, but it also forced the shorts to buy at a higher price to cover their calls. That surge in volume also caused the price to rise to almost $500 in a few days.

It went from $4.80 to over $500. The hedge fund eventually buys at $90 to cover their shorts and now is getting bailed out from other hedge funds.

Shorting is when an investor borrows shares and immediately sells them, hoping they can scoop them up later at a lower price, return the borrowed shares and pocket the difference. Click To Tweet

If you’re looking to trade options, we recommend Danny Devan’s How to Trade Options Course. Currently, it comes with a free discord and almost daily lives letting you know how to read fundamentals and manage risk. Click here for the full course curriculum.

There is a ton of manipulation going on right now. This is not advice. Please do your own due diligence and consult with your financial advisor before investing in any stocks.

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