Tuesday, February 02, 2021

I understand how shorting stock works, but not why it would ever actually happen

Periodically something happens in the news that requires an explanation of what "shorting a stock" means and how it works. Essentially shorting a stock is betting that it will go down rather than up. The explanation for how someone can make money from shorting is always more or less the same and it goes something like this:
To short a stock the investor will borrow some stock in that company from someone who already owns it and promise to return the stock at a later date. The investor then sells the borrowed stock in the market. Then later when it is time to return the shares that were borrowed, will buy the same number of shares back from the market. If the stock went down in the meantime, the investor successfully shorted the stock and pockets the difference.
So here's my question: why would anyone ever loan anyone stock? This isn't like my neighbor's snowblower or a prom dress where the reason for wanting it is obvious. If someone asks me to borrow something I'm only going to loan it to them if I understand why they want it and that reason makes some sense to me. If my neighbor came over and asked to borrow something weird, like that old pile of rags in my basement, I'd want to know why he wants it before giving it to him.

It's the same thing with stock. If someone asked to borrow my stock, I'd want to now what they want to do with it. If the person who asks happens to be one of those investor types who seem to know a lot about the stock market, wouldn't I assume he planned to short the stock? And if that's the case, I would know that my investor friend has some good reason to believe my stock is about to go down in value. Put another way because shorting is really the only reason that anyone would ever want to borrow stock, and shorting it only works if you're pretty certain the stock will lose value, doesn't that mean that I should never loan anyone stock if they ask to borrow any. A better move when asked is to politely decline, and then go out into the market and sell the stock myself before it loses value.