The financial market practice of short selling is much in the news. Indeed it has been banned in the US and UK for the immediate future. What is it?
This is how it works...
1) Bank 1 thinks that the Tesco share price is overvalued and that it will soon fall.
2) So Bank 1 borrows 500 shares in Tesco plc from another financial institution for a small fee.
3) Bank 1 then sells them for say £2 each to Bank 2.
4) Tesco share price does indeed fall a few days later to just £1 each.
5) Bank 1 now buys the 500 shares in the market for £500 and then returns them to the financial institution that it borrowed them from.
6) Bank 1 makes a profit of 500 x £1 = £500 minus the fee to borrow the shares.
So this is a great trading strategy as long as the share price does indeed fall.
If instead it rises the risk to Bank 1 is potentially massive.
Sep 20, 2008
Short selling explained!
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1 comment:
Hi, great book. I m a unsophisticated private investor trying to become a sophisticated private investor. I have been involved with a lot of studying and reading including Fred Harrisons Boom and Bust 2010, Howestreet, Financialsense, and economic discussions on globaledgeinvestors and banter on housepricecrash/ADVFN related forums. I believe we could be heading for grim times ahead after the bursting of the credit bubble, and the last time short selling was banned was in 1929 interestingly enough. Are we really doomed to repeat mistakes of the past? What a week we've had with Lehman brothers, AIG, HBOS etc. As they say, every cloud has a silver lining, and this credit bust should yield some bargains at the end of it, I hope this book helps me in this quest in securing my financial future.
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