Episode #109: “The Art of the Downside: What Short Selling Really Is”

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Transcript

Welcome And Topic Setup

SPEAKER_00 0:01

Welcome to the Fisco Physical Podcast. Join us today to week is we sit down with the founder of Alchemy Wealth Management and author of your physical physical, Ryan Nelson. Tune in to gain valuable insights and practical tips as we simplify complex financial concepts into digestible lessons. From budgeting to retirement planning, this podcast is your go-to resource for mastering financial literacy.

What Short Selling Really Means

Aaron Hoisington 0:33

Welcome everybody. This week's episode of the Fiscal Physical Podcast. I am here with the founder of Alchemy Wealth Management, uh uh Ryan Nelson. And uh Ryan, what's uh what's the good word on your end, my man? Yeah, I'm doing well today. How about yourself? Yeah, not too bad, man. Not too bad. Just uh just ready to ready to dive into this week's episode, hopefully uh share some stuff with the listeners here. And uh um today we're gonna talk about uh uh as this uh title of the episode is uh eloquently named, the art of the downside, what short selling really is. So um I I'm excited about this. Uh first off, I have a question for you though. Have you ever seen the movie called The Big Short?

Ryan Nelson 1:12

I I yeah, I think so. We that that's with uh those actors.

Aaron Hoisington 1:17

Yeah, yes, yes. Steve Carell is like one of the guys, like um, I think Christian Bale is the other guy, which is he played Batman. But uh um anyway, it's a movie about the 2008 financial crisis and like what led up to it. And uh it's a really interesting movie, and they kind of break it down, um, similar to how you kind of do you you they make it really easy and they use like analogies that most people would understand about like what led to like you know, uh the the crisis and the the housing issues and such too. So um if you guys haven't checked it out, we're not sponsored by them, but I'd recommend like it's uh it's kind of cool. But uh yeah um anyway, I want to know from your point of view here, um, you know, what actually you know shorting a stock or short selling or shorting a company, like what that actually means nowadays and pros, cons, like what do what do you how would you describe this, I suppose?

Mechanics And Profit-Loss Math

Ryan Nelson 2:05

Yeah, um, so it's actually probably more straightforward than most people think. Um and yeah, probably a lot simpler than I think a lot of people think. I love that. Yeah. So um anytime we buy a stock, we're effectively betting um that the company or the price will go up in value, right? So we buy Apple computers at$100 a share. We're hoping it will go up to like$120. We can sell it, make our$20, right? A short sell is the opposite. It's effectively a bet that the price will go down. So you're betting, you know, if Apple computers is$100 now, you're hoping it drops. So the way that it actually works is you're gonna borrow the share, then you're going to sell that borrowed share, and then at today's price, so you're buying borrowing that share, you're selling it today, then you're gonna wait and hope that you were right in that stock price drops, then you're gonna buy back that share at now that hopefully cheaper price, okay, and then sell it back to or give it back to the person you borrowed from. So again, if I was to do this, like if we were to use an example here, let's again pretend you know company XYZ is at a hundred dollars a share. So you have company XYZ, let's pretend I borrow it from you. Okay. So I'm gonna have to get company XYZ back to you. One share. I just borrowed one share from you, I have to get you back one share. So it's at a hundred bucks a share now, so I sell it. Perfect. I now have a hundred bucks. I now sit around, I hope that company XYZ drops. Let's pretend it drops to 80 bucks. Perfect. I now buy it back at 80 bucks, I give you back your share. I say, here's the one share that I borrowed from you, here's your one share. But I remember I sold it for 20, 100 bucks, I bought it back at 80, so I'm left with$20 of profit, right? So when it went from 100 to 80, I made 20 bucks by borrowing it, right? By borrowing it from you, selling it, buying it back, and giving it back to you. So that's effectively what shorting a stock is. You're usually not I don't even, I don't think ever borrowing from another individual. You're gonna typically borrow from your brokerage, the the the brokerage um company that you're working with. Um but the the concept is identical.

Aaron Hoisington 4:11

Okay.

Ryan Nelson 4:11

So that's how a short sale works. So when would you short a stock? Effectively, you would do it if you believe the company is overvalued or like in trouble, financial trouble or something, um, and you think the price is gonna decline. Or if you want to hedge risk in your portfolio, so there would be a way to reduce some of your risk in your portfolio if you have a lot of exposure to a certain company. Um, and then hedge funds could use it to express negative views or again balance out other positions effectively, hedge some risk there. But so this is a pretty risky process. Yeah so if we think again, if I just buy company XYZ for a hundred bucks, what's the absolute most money I can lose? A hundred bucks. I buy it at a hundred bucks. If it went to absolutely zero and I got nothing back from it, I'd lose a hundred bucks. And even that's pretty unrealistic, right? Um typically there's gonna be some sort of value there, but in theory, I could lose a hundred bucks. Now, if I short a company, so let's say what's what's the most I could lose if I short a company? So if I if this take the same company, XYZ, and I short the company that's worth now a hundred bucks a share. I guess you could lose a hundred bucks. I could do the So it's interesting, is so let's say I borrow that company from you at a hundred bucks and I sell it, so I now have a hundred bucks of profit, but I was wrong. The company didn't decline, it goes up in value, uh-huh, so it goes up to a hundred and fifty bucks. Uh-now I have to go buy it for 150 bucks to get back to you. Yeah. So I just lost 50 bucks. Sure. But what if it went to 200? 200 bucks. Sure. 300 bucks. Yeah. So what if it goes to 500 bucks? I bought it from I borrowed it from you for 100. I sold it, or I borrowed one share from you, I sold it for 100. If that stock goes to 500, I know how I only have 100 bucks from a sell. I have to I have to get you your share back though. So I have to go buy it for 500. I just lost 400. Yeah. What if what if the stock really takes off? It really starts running up and goes up 10x or something crazy. Now you can imagine. So there's no there's no theoretical end to how much you could lose in a short sale. Right. And that would in that example, that was per share we're talking about. So usually people aren't doing this with one share, they're doing it with tens or thousands, tens of thousands. Um, so it can be a very risky proposition.

Aaron Hoisington 6:27

Yeah.

Risks, Unlimited Losses, And Margin Calls

Ryan Nelson 6:27

Um, so when you buy a stock normally, the most you can lose is your original investment. When you do short selling, there's actually no limit on how much you could lose. You could end up losing a lot more than really all of the money you have. Yeah. You could actually go into debt by short selling. You could lose all of the value you currently have and actually owe more. Um there's something. Have you ever heard of a short squeeze? No. No? No, I don't think so. No.

Aaron Hoisington 6:55

Maybe I should go back and watch a movie on it. Yeah, with some accessories.

Short Squeezes And GameStop 2021

Ryan Nelson 6:58

So in some extreme situations, this is kind of maybe a fun aside. But so there's these um short sellers can get hit with a short squeeze. So do you remember GameStop in 2021? So basically that was a short squeeze. So uh on on uh Reddit, right, a bunch of people uh kind of banded together. They identified that there were a bunch of shorts on GameStop. So imagine again, I have the short on GameStop. So there the brokerage, so I borrowed it from a brokerage. Now there's certain limitations. The brokerage will let me borrow this fund, but only up to certain amounts. So I have to have certain money with them. And the brokerage will call this back. And eventually they'll say, if they start to see my account balance get like too low or proportionally, they'll say, Hey, we need that share back today. Right. We don't trust you. We don't trust it is getting to a point where we don't trust you're gonna be able to pay us back. Yeah, so you owe us today, get this share back to us, you know, whatever, effectively now. And so then now, if me, if I bought company XYZ, or if I if I did a short on company XYZ at$100, I sold it at$100, it's now gone up to$200. I don't want to have to buy it at$200. Right. But if the brokerage is forcing me to, then I gotta go buy it at$200, give them their share back, right? And guess what? By me buying it at$200, that helps increase the price. So now all these people, what you what you end up seeing is you can put a short squeeze. So all these people have shorted the stock. Now people start buying it up because they see it's shorted. Now all the people who shorted are forced to go buy it, right? Which causes the price to go even higher, which caused other people who shorted it to buy it, which causes it to go higher, which causes other people who shorted it to buy it, which causes it to go higher. That's what so that's what happened with GameStop back in 2021. That was a short squeeze. Um, and so it just caused the stock to go so high. Oh, it's what you also saw. Then all these people sort of got taken advantage of. They bought it, they're like, oh, this is crazy. So they're buying into GameStop, not even realizing what's happening while it's at the top. Of course, it wasn't actually worth that much. Right. People got forced into buying it, and then they buy in at the top and they lose a ton of money, right? Um, so that was a very uh unfortunate circumstance for most retail investors who tried to kind of capture that. Um, another reason why you probably don't want to uh uh, you know, if it sounds too good to be true, it might be, and like you really want to understand what's happening behind the scenes. Um but uh anyway, so that's an example of a short uh short screw squeeze in it, and um it doesn't happen like all that often, but it's that buying pressure can push the prices higher and higher and higher, creating a more of a kind of spiral there. But it's it's kind of funny because it's opposite of normal, it's the price going way high as opposed to the price falling. Um so yeah, kind of interesting. But that's a short squeeze. Really bad for all the people who shorted it. Theoretically, good for the people who own it outright, but again, it's kind of uh just artificially inflated value. It's not the the company actually isn't worth any more value, it's just these technical things happening in the market that's required.

Aaron Hoisington 9:57

That's that's pushing it up or or down or whatever. So that's that's uh that's interesting. I remember back in 2021, 2021, 2020, 2021 when that GameStop thing was happening, like all these like memes and things are just getting thrown around, like they're like, oh, like hold the line and like diamond hands and all these different things. And I was like, I have no idea what's going on here. Like, and I like researched it and I like looked at and I was just like, but at that point, GameStop was you know freaking 150 bucks a share. Right. And I was like, I I don't know, this thing is like traded at like you know, like a hundred, like, or like it's traded at like 30 bucks a share normally or five bucks a share. I can't even remember what it was, but like it was just like I was like, what happens when it like goes back down? Like, dude. I was like, at some point I'm gonna have to like I don't know what to do with this kind of thing. So I was like, I think I'm better just sitting this one out.

Ryan Nelson 10:47

Like I I I mean, unfortunately, I think I think just like you, most people who participated in that didn't fully understand it. And again, that's like sad, but it it was people again. I would explain what they were. Most people who got in on that were more like gambling than investing. Yeah, they didn't understand what was happening, they saw or read something that sounded very attractive, wanted to somehow take advantage of it, kind of get that shortcut. And most of them ended up getting burned. Right. You know, um, so it is unfortunate, but um nonetheless, hopefully this is empowered somebody else, maybe um not fall victim to that um at some point in the future. Absolutely.

Aaron Hoisington 11:23

No, I think that that's important, yeah.

Misconceptions And When Shorting Fits

Ryan Nelson 11:24

Yeah, so the reality is sort of quote unquote normal investors are gonna very rarely short a stock. Okay, because there's like I said, there's like outside, there's uh effectively unlimited amounts of risk, right? Yeah, um, so it's very high risk, it can be highly complex, there's a lot of emotional pressure. Um so for most people, right? The long term you just want to invest in quality companies, it's gonna be far safer and a more productive strategy than trying to do something like this. And the reality is most of the time most stocks trend upwards, right? Right? So in general, most stocks go up over time, and so betting on them going down has historically been a bad investment. Right. So short shorting can be done efficiently. There are times where you can do it to reduce risk of other holdings, but again, that's a very complex strategy um that we're not talking about on on uh on this quick podcast here. Awesome. Um, so the big the big short um basically you know the movie you're talking about that had to play that that was during the 2008 housing crash. Yeah, so it's the same thing, but what they were um shorting in the big short was not individual stocks, it was mortgage backed securities. Gotcha. Um, but it was the same concept. But so effectively what they did was they shorted these mortgage backed securities, wait so they borrowed mortgage backed securities, sold them, so sold them for a lot of money, call it, waited for the market to crash, was able to buy them back at these very low prices, and they made the difference, right? So they effectively profited from the market declining because they shorted it, if that makes sense. Yeah, definitely. Um there are some common misconceptions, I think, that you hear out there. So they'll say like short short sellers destroy companies, like like if everybody shorts a company, they destroy it. Right. That's just simply just not not true. Um that doesn't. In fact, typically it's gonna just not really affect the company, you know. Um uh I would say um, you know, one thing short selling can do is it can help with almost market corrections, like if there's uh fraud or something, um, it can help identify like if there's some sort of fraud, if a bunch of people start shorting a couple certain company or something. So there can actually be some positives there. Um but yeah, short sellers definitely don't control the market. They're a tiny, tiny, tiny minority compared to longholders, people buying just normal stocks and holding it for the long term. Um, so uh like effectively our takeaway would be short selling is like an advanced strategy that carries unlimited downside. It's not a tool for long-term retirement planning. Um, for most people, the right process would be owning a diversified investment portfolio and letting compounding right time do the work. So we've said this saying a hundred times, we'll probably say it a hundred more times, but time in the market beats timing of the markets. Short selling is kind of a market timing play. You're trying, you're hoping the market goes down over the short period of time. So again, time in the market is gonna beat timing of the market. So for the vast majority of people, they should just buy a diversified, nice, again, kind of boring, steady, proven portfolio. Um, and not, you know, short selling is gonna be that flashy bells and whistles thing that probably is gonna result in if you don't know what you're doing, uh, is more likely than not to result in uh negative results.

Aaron Hoisington 14:57

Awesome. That that was great, Ryan. That was super, super, super helpful with that in in terms of kind of what that is, when it's leveraged, when it shouldn't be leveraged. And as as always we say on this, like, you know, make sure you talk to your financial advisor before you, you know, potentially you're doing anything like this, um, and ensure that you know whatever decision you're making is is right for you to say the least, there. But uh um awesome, man. We'll go ahead and pause real quickly here, and then uh we'll be back. Uh everybody uh hang tight with us for the personal section.

SPEAKER_00 15:25

And now to put the personal in personal finance.

Aaron Hoisington 15:31

Welcome back, everybody, to this side of the physical physical podcast. Uh the personal section here. I'm still with uh Mr. Ryan Nelson and uh Ryan, I got a question for you here. And uh I'm uh I'm curious to see what your answer is because you know sometimes I'll ask you this, you're like, no, I I really enjoy what I do. But uh so my question is if you could swap jobs with anybody for one week, what who would it be or what would it be? Like what would you s swap to? What industry would you go into, or what job would you take over?

Stay The Course Investing Mindset

Ryan Nelson 16:00

Yeah, you know, I think it'd be kind of interesting to be like uh do something for the Packers, for the Green Bay Packers, and do something in like the coaching realm. Um I think that you know, I I think maybe like a decade ago, I was like of this impression that like man, these people are like geniuses and there's billions of dollars of resources and like they like know where like have all like unlimited resources. And I think like the I think I I now believe their resources aren't as unlimited as I once thought. And um a lot of you know, like quite honestly, a lot probably a lot of the best coaches in the world are doing like high school, like coaching some high school team or something, right? And they've never made it into the NFL because it's such a small pool that can make it there. And with like the nepotism in the industry, which isn't all bad per se, but like it's hard to crack into the the the league, so to speak, right? Um yeah, I think it would just be interesting to A, see behind the scenes, see how much they really do know, how much they're just winging it. Um, but uh also see if yeah, there is any opportunity to create any any value there.

unknown 17:08

Yeah.

Personal Segment: NFL Coaching Curiosity

Aaron Hoisington 17:09

No, I think that uh and it's funny just for the listeners out there, like uh uh I I ask these questions, but like we don't get to see each other's answers or what we're gonna say or anything like that. It's it's so funny you said that because I'm ex exactly the same. I'd like to be in a fly on the wall or just even I don't know, an equipment manager or something like that, like for like an NFL team to see what goes into the week of preparing for a game. Yeah, that'd be great. Like, what does it look like when you you know fly home or you finish your game on Sunday? What is your Monday, Tuesday, Wednesday, Thursday, Friday? Like, what is the preparation like during the season? Like, what do you actually like? What resources can you draw on? Because like, you know, I I read something one time that it talked about like that Monday after a game, like most players are take that's a recovery day. Right. They're just like getting so beat up like to in the game, like, but for coaches and such, they're already game planning the next one. So I think like being a you know, a quality assistant or something like that for like, which probably doesn't pay very well for those kind of things. So like I I also think I'm like maybe I should be like, you know, the you know, and work out something for a week where I can make a ton of money, but I do think it'd be fascinating to see what goes in behind like the scenes of a you know, even could be an MBA or professional, just something like that, to where like you're like, what do you guys actually do? Like, how do you prepare? Like, what does Wednesday practice look like? And um, you know, a lot of those coaches that are really, really good, like you know, your Bill Belichick's and you know, back in the day, like had this regiment that they were just like, Cool, this works, we're doing exactly this. Sure, this is what we're doing. And so to see like what works, what doesn't work, I think would be super fascinating to see too.

Ryan Nelson 18:44

So in a week would probably be plenty of time because I think those guys are working uh seven days a week, like uh 15, 16 hours a day. So yeah, a week would probably be plenty.

Aaron Hoisington 18:53

Probably it's a it's it's a reason why like you think about like people talk about like, oh, the NFL is like only you know 18 weeks, and you're like, well, actually, like if you you know you got your preseason, you got your your summer camps, you got your you know, if you make the postseason, you could be playing into like February or something like that, too. So you get like everybody talks about I see like uh you know after coaches finish or uh uh players finish, they go to Cancun or do these extravagant trips, and I'm like, Good, you guys have earned it. Like you're working like those uh I know that like tough job. The uh like Matt Lafleur, like the coach of the Packers, like he works, he he talked about like how much he works and how much people prepares and like that just meticulous like preparation for all these things. Very impressive. So yeah, I'd love to see that. I'd love to also hear what our listeners uh what job they would switch for for a week there and see what uh see what actually happens and what the I I bet you we get some pretty good responses from that. So um let us know everybody. These episodes drop every Tuesday. We'd love to love to hear your feedback and uh uh Ryan, appreciate the uh the insight as always, my man, and uh I'll leave it uh to you to play us out. As always, stay the course.

Listener Prompt And Closing CTAs

SPEAKER_00 19:58

Thank you for joining us for the Fiscal Physical Podcast. Until next time, happy listening. And as always, stay the course. If you have a question or topic suggestions, please email us at podcast at alchemywealth.com. If you enjoyed today's discussion, subscribe to the podcast to ensure you never miss an episode. And consider leaving us a rating and review on your favorite platform. This helps other listeners like you find this channel. For more resources, you can visit Alchemy Wealth Management's website at www.alchemywealth.com or find your physical physical book on Amazon. We'd be remiss if we didn't mention the personal finances just then. First of all, please don't take anything we say as advice. The printed content is for informational and entertainment purposes only. It's not an offer or a solicitation, nor should it be construed or relied upon for tax, legal, or investment advice. It doesn't consider your personal financial situation or objectives and may not be suitable for you.