← Money Lessons with Andrew Temte, PhD, CFA
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When you buy a stock, the worst thing that can happen is that the company fails and the stock price goes to zero. You lose what you paid. The most you can lose is 100% of your investment. When you short a stock, the math runs in the opposite direction. You lose money when the price rises. And there's no ceiling on how high a stock price can rise. Foreign. Hi, I'm Andy Tempte and welcome to Money Lessons. Join me every Saturday morning for bite sized lessons that are designed to improve financial literacy around the world. Today is June 6, 2026. Last week we covered the quarterly rhythm that shapes life as a public company. The filings, the earnings calls, the way management's job changes once a company is owned. Public, shareholders, all of that assumes you own the stock and you want the price to go up. Today we look at the opposite trade. Selling shares you don't own in the hope that the price falls. The practice is called short selling, and it's one of the most misunderstood mechanics in the stock market. Now, short selling is older than most listeners would guess. Back in our October 18, 2025 episode, we met the Dutch East India Company, or the VOC, the company whose transferable shares created the world's first true stock market. One of its co founders was a merchant named Isaac le Maire. In 1605, Le Maire was forced off the VOC board amid accusations of misusing company funds. He spent the next several years looking for ways to get even. In 1609, Le Maire organized a secret syndicate of merchants whose sole purpose was to drive down VOC's share price. They did this by selling shares they didn't own, agreeing to deliver shares at a future date at a price that was set today, and planning to buy the shares back more cheaply before delivery. This was the first documented short selling operation in financial history. VOC's directors lobbied the Dutch authorities for help. And on February 27, 1610, the Dutch government issued an edict targeting the practice. The first stock market regulation in financial history. The pattern has repeated itself across four centuries. Short selling appear, prices fall, authorities ban it, and the ban eventually lifts and the practice returns. That repetition tells us something. Short selling makes people uncomfortable, powerful people especially because it's a bet against a company at a moment when everyone else is rooting for it to succeed. Now, let's walk through the mechanics with a concrete example. Suppose that you believe the shares of a company called Widget Corporation are overvalued at their current price of $50 per share. You think the price is going to fall. Here's how you'd profit from that view through short selling. First, Your broker borrows 100 shares of Widget Corporation from another investor who owns them, often a large institution that's willing to lend those share shares for a fee. Second, you sell those borrowed shares immediately at the current market price of $50, which puts $5,000 into your account. Third, you wait. If the price falls to $40, as you predicted, you buy 100 shares back at the new lower price for $4,000. And finally, you return those 100 shares to the lender, closing out the loan, and you keep the difference, $1,000, as your profit. Remember, you weren't borrowing money, you were borrowing shares. Two costs reduce that thousand dollar profit. The broker charges what's called a borrow fee, which is financial lingo for the privilege of borrowing the shares paid for as long as the lo open. And if the company pays a dividend while you have the borrow open, you owe that dividend to the lender because the lender is the one who would have received it otherwise. There's also a timing risk that has no parallel. When you buy a stock outright, the investor who lent you the shares can demand them back at any time. If your broker can't find another lender to replace the borrow, you'll be forced to buy shares in the market and return them immediately, whether the price is favorable or not. The trade is on someone else's clock as much as your own. Now, here's the part that every short seller must understand before placing this kind of trade. When you buy a stock, the worst thing that can happen is that the company fails and the stock price goes to zero. You lose what you paid. Painful, but bounded. The most you can lose is 100% of your investment. And oh, by the way, if anybody ever tells you that you can lose more than 100% of something, that's just bad math. You can only lose 100% of something anyway. When you short a stock, the math runs in the opposite direction. You lose money when the price rises. And there's no ceiling on how high a stock price can rise. Let's go back to our Widget Corporation example. You shorted 100 shares at $50 a share, collecting $5,000. Now imagine that you were wrong and the stock price rose to $200. To close your position, you have to buy 100 shares back. But those shares now cost 20 dol. $20,000. You open the trade for 5,000 in proceeds, and you have to spend $20,000 to close it. You've lost $15,000, three times what you originally invested. And if the price keeps climbing, your losses keep climbing with it. This is what financial professionals called asymmetric risk. Long positions, stock ownership cap losses at 100%. Short positions don't cap losses at all. Hence the asymmetry. Now, when too many investors are short the same stock and the price starts rising sharply, something dangerous can happen. Short sellers face growing losses and are forced buy shares to close their positions before the losses get worse. That buying drives the price higher, which forces more short sellers to cover, which drives the price higher still. This self reinforcing feedback loop is called a short squeeze. The most spectacular short squeeze in modern history happened in October 2008. The German automaker Porsche had been quietly accumulating an ownership position in Volkswagen for years. On Sunday, October 26, 2008, Porsche announced that it held a combined position equivalent to roughly 74% of Volkswagen's shares. Part of it was stock that was owned outright and part of it was derivative contracts tied to Volkswagen's share price. Between Porsche's position and the 20% stake that was held at the time by the German state of Lower Saxony, only about 6% of Volkswagen's outstanding shares were available for trading. Meanwhile, short sellers had sold short roughly 12% of the company. There was not enough shares in the market for short sellers to buy back. The result was extraordinary. Volkswagen's share price moved from around €200 on Friday, October 24 to over €1,000 on Tuesday, October 28. For a few hours, Volkswagen was briefly the most valuable listed company in the world by market capitalization, overtaking ExxonMobil at the time, hedge funds that had been short Volkswagen lost an estimated $30 billion collectively, much of it in a matter of days. Now, what does all this mean for you? Almost no retail investor should short stocks. And the asymmetric risk is the central reason. When you believe a stock is undervalued and you buy it, you can hold the position for as long as you want. There are no daily costs draining your no one can force you to sell and the most you can lose is what you paid. When you short a stock, you believe it's overvalued. None of the above is true. Borrow fees, they accumulate daily. The lender can recall the shares at any time and force you to close at an inconvenient moment. And your potential losses have no ceiling. There's a well worn saying in the markets. Markets can stay irrational longer than you can stay solvent. The short sellers who bet against Volkswagen in October of 2008 were probably right about the fundamentals of the business, but they lost anyway. Being right about the destination doesn't help if the trip bankrupts you along the way. If you ever find yourself convinced a particular stock is going to fall, the cleanest response from most investors is the simplest one don't own it. Now, we're going to talk about derivatives contracts much later in the series, and that's a possibility. But right now the advice is don't own the stock. Now, looking ahead, short selling sits at the intersection of mechanics and information. Regulators write rules around it, exchanges monitor it, and information about who is short. What stock is treated as material information. That's because short sellers often act on information that other market participants don't have. And the question of who knows what and when is fundamental to how markets work. So next week we'll explore information asymmetry, why some market participants know things that others don't, and how the rules of the market try to keep that gap from getting too wide. So until next week, I wish you grace, dignity and compassion. My name is Andy Tempte, and this is Money Lessons. You can find the show on all the major streaming services as well as out on YouTube. Please like, subscribe, rate and most importantly, share this public educational good with your friends, your family, your colleagues, and maybe a neighbor. The show was produced by Nicholas Tempte, and we'll see you next time on Money Lessons.