The stock market is something of a divisive subject for many people, often due to people not understanding what it is or what its purpose is.
Many also associate possible elitist connotations with the financial system as a whole, as it seems like something only the rich and powerful can be involved with and benefit from.
Whilst this is certainly true to an extent, anybody with the luxury of disposable income can look to jump on board and invest in a few stocks.
Many might have only heard of stocks being shorted thanks to the Adam McKay film ‘The Big Short’.
This film, based on a true story, detailed how financial investors took advantage of the upcoming housing market crash between 2007 and 2008.
It’s this kind of practice that certainly adds to the negative associations with shorting stocks.
So what does it mean if a stock is being shorted, and how does the stock market work anyway?
This article will offer an introduction to the stock market and guide you on how to see if certain stocks are being shorted.
What Are The Main Functions Of The Stock Market?
1. It’s a way of measuring the performance of the economy and financial markets – i.e. how is the country/region doing at present compared to where they were in, say, 2001.
This shows us whether things are getting better or worse over time.
2. It determines what kind of investment opportunities investors can take on and gives them an idea about the future demand for investments across different sectors (i.e. what will be in demand 5 years from now).
3. It provides a benchmark against which the real estate market can be judged. Because when people buy houses, they need collateral.
The housing market might look like one thing, but it doesn’t necessarily have to be as strong as the other markets.
So if your house value looks good, then you’ve got something that someone else needs to borrow money against.
The same goes with stocks; if a company has been able to do well, then it means there must be demand for that type of investment.
What Is The Difference Between Stocks, Bonds, And Cash? Are They All Investments?
Cash is just about keeping some amount of money in reserve and not investing it. Stocks are shares of ownership in a company.
Bonds are loans made by banks to companies so that those companies can invest their profits in new ventures.
All three are types of investment instruments that you can trade in the stock exchange or via direct brokerage firms.
In general terms, though, if you’re looking to make money, you should probably look into the stock market.
What Is The Meaning Of “Stock”?
Stock refers to equity – that part of a corporation that isn’t owned by its customers or employees. Companies issue their stock to raise funds and share it among shareholders.
Stockholders own the company in return, meaning that they have a claim on its assets.
Most major corporations today issue shares of stock, although smaller businesses often sell only shares of preferred stock.
Why Is It Called “The Market”?
Why do we refer to the stock market? Well, because we call everything “the market” these days. Whether it’s politics, religion, cars, phones, or the stock market – we use the term “market”.
It’s also known as a market simply because it’s a forum through which things are bought and traded.
What Is Short Selling?
Most simply put, when an investor takes a ‘short’ position, they are betting against the market, hoping to profit when the prices decline.
This is opposed to taking a ‘long’ position, in which investors hope the price of the stock will rise over time.
Short selling allows a person or institution to bet on the direction of the price of a particular security in advance, without actually owning the security.
They can therefore profit from falling prices while reducing the risk associated with buying securities.
When a shareholder sells a security short, she or he hopes that the price of the security falls below the current market price.
As the investor pays less than the prevailing market price for the security, this reduces the potential capital loss. It also increases the profit potential.
Shorting works because the majority of buyers wait until after trading begins before purchasing securities.
Since everyone wants to get maximum exposure to the stock market, the bid-ask spread widens, causing stocks to drop.
Investors who attempt to gain by shorting become sellers at a later time, usually when the price of the security recovers.
However, if the price of a stock rises above the short sale level, the seller may lose more than the initial cost.
This occurs due to commissions involved and the fact that the buyer will likely pay for inventory rather than actual shares.
Who’s Allowed To Short Sell?
Only individuals and institutions who can meet certain requirements are allowed to short sell. One must be an accredited individual or institutional investor. These include:
- Individuals with a net worth of at least $200,000;
- Corporations whose total assets exceed $100,000,000;
- Institutions such as pension plans, endowments, trusts, foundations, insurance companies, and registered broker-dealers.
How Can You Tell If A Stock Is Being Shorted?
Stock Exchanges
Stock exchanges release the relevant data on stocks, including short interest, on the third Monday of each month. This data can be accessed directly through the stock exchanges websites such as NASDAQ.
Here, you can see the specific details of each stock listed, including the level of short interest being shown in that particular stock option.
To access this data on the NASDAQ website, simply enter the code or name of the stock you wish to investigate.
Once you go through to that stock’s page, you can select Short Interest from the options on the left-hand side of the page.
This then shows you how many shares are being shorted, the Average Daily Share Volume, and the Day’s To Cover column.
The Day’s To Cover column is calculated by dividing the number of shares shorted by the average daily share volume.
So what does this mean? The higher the figure in the Day’s To Cover column, the greater the amount of genuine short interest in that stock.
Current Events & The News Cycle
Another way to look at which stocks may be being shorted is to follow the news media cycle and keep an eye out for some key signs.
Following business news as well as any geopolitical happenings can offer an insight to shrewd investors.
For example, if a company is in the news featuring mostly negative coverage, and the backlash has extended onto social media, then the company may be about to drop considerably in value.
Another example is if there are any geopolitical conflicts, this could affect companies based there or who may trade with the nations involved.
Final Thoughts
And that’s really all there is to it. Short stocks can seem like a bit of a headache at first, but if you start monitoring them using the methods above, you’ll soon become fluent in the process, allowing you to make shrewd investment decisions.
Financial Disclaimer
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