Welcome to our OIG meeting this week!
We talked about Short vs. Long trading. Several members asked about short selling throughout the semester and we decided to do a tutorial to help everyone understand it better.
Firstly, long selling, is basically what we are doing with our portfolio. In long selling, one purchases the stock and holds it for a long time expecting its value to increase. On the other hand, short selling means the selling of a stock that the seller doesn’t own. More specifically, a short sale is the sale of a security that isn’t owned by the seller, but that is promised to be delivered. In another words, when you short sell a stock, you borrow stocks from your broker and you sell the shares sooner or later, you need to buy back the same number of shares and return them to your broker. If the price drops, you make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.
Short selling, is the opposite of long selling. Investors want a decrease in value of the stock and want the company to perform poorly so you can profit from the difference in prices at the same time.
The two main reasons people decide to short sales are to speculate or to hedge.
Because the nature of short selling is against the market, SEC has been trying to establish more rules to regulate this sector of financial market. For example, SEC has more specific requirements and standards for setting up a margin account which is an essential step in the short sell transaction.
There are different reasons for investors to choose long term investment or short selling. Long term has fewer risks compared to short sell.
Compared to risks of economy and the risk of inflations of long term investment, the frequent transaction involved might help investors gain some purchase power. At the same time the downside could be severe for short sell. Since it’s short sell, one cannot stay in the short sell state for a long period and the general trend of market is growth which will be a disaster for short seller. The loss can be infinite as the stocks do better while the profit is limited plus heavy transaction fees and insurance leverage. Short squeeze can wring the profit out of your investment. When you take everything into account, you could do the right thing at the wrong time, such as the dot.com bubble in early 2000. There are also limits on the types of funds that can process short sale.
Last but not least is the ethical problem. It’s safe to say that short sellers are not popular people on Wall Street because they make money in bear market. Although there are illegal practices of “short and distort” involved in short sell, we should remember the contributions of short selling to the general financial market. Short selling helps increase liquidity and unbiased observations of companies as well as working at the front line of finding financial fraud in companies.
If you would like to know more about definition of short vs long and how they differ, you can visit Investpedia.com to learn more.
Don’t forget that we will have our election next week. Come and support and be part of OIG next year. Everyone’s vote counts.