By short selling, we mean selling a stock that you do not possess, with
the intention of buying it later. Short selling in general business is
very common, and we think nothing of it. Manufacturers frequently sell
goods that are not yet made, to be delivered at some future time.
Selling stocks short is a similar transaction, except that in a majority
of cases delivery of the stock must be made immediately.
However, your broker can attend to that by borrowing the stock. As
explained in the preceding chapter, when the market is active most of
the trading is done on margin. Your broker buys a stock for you, but as
he has to pay for it in full, it is customary for him to take it to his
bank and borrow money on it. A bank usually lends about 80% of the
market value, but if some other broker wants to borrow this stock, he
will lend the full value of it. If that particular stock is very scarce
and hard to get, the lender of the stock may get the use of the money
without any interest.
Therefore, there is an advantage to the broker in lending stock, and for
that reason it is nearly always possible for a broker to arrange
delivery of stock for you if you wish to sell short. When you instruct
him later on to buy the stock for you, he will do so and deliver it to
the broker from whom he borrowed it, who will return the money he
received for it.
When you sell stock short and the price goes up, you will have to pay a
higher price for it. Therefore, to protect himself against the
possibility of losing, your broker demands a payment from you just the
same as you pay margin when you buy stock.
Short selling is something that we do not recommend very much to our
clients. We think it is not advisable to do any short selling as long as
there are good opportunities to make money by buying; but when all
bargains disappear, as they do sometimes, you must either sell short or
else keep out of the market entirely. At such times, there may be many
opportunities to make money by short selling, and we do not consider
that there is any reason why our clients should not take advantage of
Of course, great care must be exercised in selling stocks short. You
might sell a stock short because you know the market price is 100%
greater than its real value, but it is possible for manipulators to
force it up a great deal higher; and if you are not able to put up
sufficient money with your broker to protect him, he will buy at a high
price and you will lose the money you have put up with him. In some
instances, stocks are cornered and the short interests are forced to buy
the stocks at prices that represent enormous losses.
It is a common thing to read about the short interests in certain
stocks. All stocks that are sold short must be bought sooner or later,
and when that buying takes place, it may affect the market very much.
Therefore, if it is known that there is a big short interest in a
certain stock, we should expect the stock to sell at a higher price; but
sometimes the short interests break the market and force the price down,
especially when general conditions are in their favor.