There are a lot of misconceptions right now about what happened with GameStop way back when, and short selling in general. So today, I thought I’d clear up exactly how short selling works so that we can all be on the same page.
We’ve talked before about how the GameStop Corp. (NYSE: GME) short squeeze that swept up other stocks like AMC Entertainment Holdings Inc. (NYSE: AMC) and BlackBerry Ltd. (NYSE: BB) was not a “David and Goliath” story.
It wasn’t a case of the people banding together and sticking it to Wall Street. It was a carefully planned operation from professionals who likely had inside information. They know how to trade, and they know how to use social media.
They put those two together and voila: The GameStop short squeeze we’ve been talking about.
Now, I’m hearing a lot of people talking about how short selling works and that the hedge fund guys are just making free money, while Robinhood wouldn’t allow them to.
That’s not true.
Don’t Listen To the Muppets: Here’s How Short Selling Actually Works
Shorting stocks doesn’t mean hedge funds get to just sell stocks and make money.
It’s not an evil “Wall Street only” thing. Short selling is important to having the free market our country prides itself on. It is actually a key tool in creating a “real price discovery.”
And it didn’t even come from the stock market! Short selling actually came from commodities and farmers taking a short position in futures to lock in a profit on their harvest.
To short a stock, the trader has to borrow the stock from a prime broker, who will offer a list of stocks. Some are easier to borrow than others. Then, the broker lends the trader a specific amount of shares from their own client’s account.
And they charge interest on it. The banks are the ones making all the money. Not hedge funds.
And with GameStop, a very hard stock to short with a 70% interest rate… That’s not a great chance to make money. I like to keep it simple.
Feel free to email me at jeff@joyofthetrade.com with your questions on how short selling works or any other trading topic and make sure to subscribe to my YouTube channel.
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