Who are "Short Sellers"? What is "Shorting"?

Whatever part of the world you were in during the end of January 2023, you would have heard about a report on the Adani Group companies by Hindenburg Research. After the report became public, the stock price and hence the value of all of the public companies under the group fell drastically in a few days. And Hindenburg is an “activist short-seller”.

So what exactly is short selling? And why would someone want to reduce the value of a company? Read on.

So we all understand buying an asset and selling it later at a higher price to generate profits. What shorting is, is the opposite of this. Not the opposite of generating profits, the opposite of the mechanism of buying and selling later.

When you short an asset, you borrow it from someone, sell it at price X, buy it back at price Y and then return the asset to the person you borrowed it from. If X > Y, you make a profit and if X < Y, you lose money.

Let’s take an example outside of the financial markets. Let’s say you borrow an old monitor from a friend and sell it to a colleague for $1000. Two months later, your friend needs his monitor back, and your colleague agrees to sell it back to you, but for $1100. So what has happened is that you are now down $100 and your friend still has his monitor.

This is exactly what happens with short selling. The person who lent you their shares gets their shares back at the end of the chain of transactions, and you either got out with a profit or a loss. In today’s markets, there is ample liquidity for most markets for you to not have to worry about who are you going to borrow the asset from, there are enough shares/assets floating around!

But keep in mind this catch, when you short an asset, you can theoretically only gain 100% but could lose in infinite amount, since the price can just keep on rising but if it falls, it can only fall to 0.

Short selling is banned or restricted in some countries because, in essence, short selling hurts stock prices and could end up damaging the economy if all the dominoes fall in a particular sequence. But it is also completely legal in many countries because it helps in price discovery, increases liquidity and reduces the possibility and impact of market bubbles.

That’s it for this article. Let me know if you have any questions.

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