Introduction to Shorting
Shorting stocks is when you sell a stock you don't actually own. You borrowed it.
If you only have $150 when the loan shark comes to collect his $200, you're SHORT $50. That's where the terminology comes from.
When you sell stock that you borrowed, you still owe it back to the lender. So until you buy it again, you're going to be short the amount you borrowed.
Most people are familiar with the idea of buying a stock at one price and hoping to sell it at a higher price to make a profit. If you sell at a lower price, you make a loss. Pretty simple.
Generally owning a stock means you believe the price will go up, because if you thought it would go down, you'd sell it. Owning a stock is referred to as having a "long" position in that stock.
Having a "short" position in a stock is exactly the opposite. It generally means you think the price will go down. The way you make money shorting is the same though, you want to buy low and sell high. The difference is that you're doing it in the opposite order. You're trying to sell high and THEN buy low.
But you can't sell something you don't have, so the way it works is you first have to borrow the stock from someone. You then sell the borrowed stock at market value.
The lender wants their stock back, so you're hoping the price will go down before the lender comes looking for their stock.
If it goes down, you buy it for less than you sold it, and make a profit. If the price goes up, you have to buy it for more than you sold it, so you make a loss
That's the idea behind shorting. You're betting the price will go down. So process is pretty basic - borrow, sell high, buy low.
Shorting side note : fees
When you short a stock, you've borrowed it from someone else. As with most things people don't lend out valuable goods for free. The same thing applies when shorting a stock, there is a fee, similar to interest on a financial loan. This fee is simply called the Stock Loan Fee.
The Stock Loan Fee is an important factor to consider when calculating the feasibility of the short you are considering.
The rate of the fee will depend on how easy or difficult it is to acquire the stock, as well as for how long you borrow the stock.
Betting your house will burn down - Insurance is a short
Shorting a stock is a bet that the price will go down in value.
Insurance, whether it be health, home or some other insurance, is actually the same as a short when you think about it.
When you short a stock you will pay a fee to bet that the value of the stock will go down. If it doesn't go down, your loss is the fees you paid. If it goes to zero you get the original stock price, less the fees you paid.
Now let's think about something like house insurance.
You pay a fee in case something happens to your home that would decrease it's value. If nothing happens, your loss is your insurance premiums. If the house burns down (aka, it's value goes to zero) you get the the full value of the house.
The same goes for health insurance. It's a bet that the value of your health will go down. If you stay healthy, then you lose the fees you pay each month. If you get sick, you win money equal to the cost of getting you back to normal health.
So insurance, just like shorting a stock, is simply a bet that the value of something is going to decrease. Insurance is essentially a bet that a bad thing will happen.
*Note: Shorting a stock is different from insurance insofar as the loss is not capped on shorting. You can theoretically have unlimited losses if the price of the stock increases. What's known as a put option is actually more closely related to insurance as the losses are limited to the fees you pay to buy the option.