Are Short Sellers The Market's Great Equalizers?

In 2015, a biopharmaceutical company called Valeant Pharmaceuticals raised the price of a life-saving drug from $13.50 per tablet to $750 per tablet overnight. 

It was one account of a string of price-gouging efforts the company had undertaken throughout the past year. Valeant’s business model revolved around these price hikes. Unlike standard biotechnology companies, which spent millions on research and development, Valeant chose to purchase companies with already-existing drugs and profit by marking up prices. 

The price-gouging strategy had done wonders for the company’s stock price, which rose to a high of $260. The customers of Valeant’s acquirees were less fortunate — many of the drugs Valeant sold, like Daraprim, were life-saving and suddenly unaffordable. 

Valeant’s unethical monopolization and price gouging strategies likely would have continued had it not been for the now-infamous short-seller Fahmi Quadir. In the Netflix documentary “Dirty Money,” she is seen initiating a massive short position on Valeant, betting that the company’s unethical practices and “creative” account management would eventually lead to a capitulation in the stock price. In 2016, Quadir’s thesis was proven correct. 

At 28 years old, she had lost Wall Street titan Bill Ackman, Valeant’s heartiest investor, more than $4 billion and ridden Valeant Pharmaceuticals from a stock price of $260 to $0 (the company currently trades under a different name).

“Short sellers are always an easy boogeyman,” Quadir said. 

Indeed, Wall Street appears to abhor short sellers, marking them down as perpetual pessimists. But the Valeant case study showed the world another side to the short seller’s persona — one that’s lucrative, morally conscious and healthy for the world. 

Still, to many, short selling remains hidden behind a shroud of mystery. So what exactly is it, and how do traders go about profiting from a short?

What Is Short Selling? 

In the simplest terms, a short sale is a bet that a company’s stock will go lower. A trader with a thesis for a declining stock can short that stock in the hope to buy it later at a cheaper price and pocket the difference. 

The complications to understanding short selling arise when you think about the selling procedure. First, how can someone sell something they do not possess? Second, how do traders profit when a security’s price declines? To answer these questions, consider an analogy. 

Suppose your friend John has a Model 1 IKEA chair. You need money, so you ask to borrow his chair, and you reach out to your friends Moe and Adam. Moe is looking for a Model 1 IKEA chair, so you sell it to him for $300. Adam has a Model 1 IKEA chair he doesn’t want, so you buy it from him for $200. When you give John back the Model 1 IKEA chair, you will have made $100, and John will have gotten his chair back.

This is how short selling occurs with stocks. When a short seller initiates a position, it’s with a stock that they have borrowed. The short seller is obligated to return the borrowed stock to its rightful owner; thus, whether the price decrease or increases, the short seller is forced to buy back the stock. 

When a stock’s price declines, the short seller makes money. 

Picking A Short-Friendly Broker

Whether an investor wants to be the next Quadir or just profit from an overbought stock, they will need a proper broker to guide them through the process.

One company that might be able to help is TradeZero, winner of the Benzinga Global Fintech Award for Best Brokerage for Short Selling in 2020 and 2021. For the short seller, TradeZero may even be a unique place.

The company is actually made up of three separate broker-dealers in three different jurisdictions, but specializes in providing some of the hardest-to-find locates on the market, meaning investors could have a higher likelihood of finding stocks to borrow for their short positions. TradeZero also reports taking its short-selling abilities to new heights with its patent-pending credit back features, which can allow investors to get credits back for locates they asked for but did not use or no longer need. 

Want to take a stab at short-selling? 

Click here to learn more about short-selling with TradeZero.

This content (“Content”) is produced by Benzinga in partnership with TradeZero. TradeZero does not endorse the Content and makes no representations or warranties with respect to the accuracy of the Content or information available through any linked third-party sites. Benzinga may receive compensation for introducing customers to TradeZero. TradeZero provides self-directed brokerage accounts to customers through its operating affiliates (“TradeZero Broker Dealers”): TradeZero America, Inc. a registered broker-dealer and a member of FINRA and SIPC; TradeZero Inc., a dealer registered with the Securities Commission of the Bahamas; and TradeZero Canada Securities ULC, an IIROC member firm and member of CIPF. TradeZero Broker Dealers do not provide financial or trading advice and do not make investment recommendations to their customers. This communication does not constitute an offer to sell or a solicitation to buy any security or instrument which it may reference. There is a risk of loss in online trading of securities including equities and options. Trading on margin is for experienced investors only as the amount you may lose can be greater than your initial investment. Likewise, short selling as a securities trading strategy is extremely risky and can lead to potentially unlimited losses. If you have any specific questions about TradeZero’s brokerage services please reach out to the TradeZero Broker Dealer in your jurisdiction.

This post contains sponsored advertising content. This content is for informational purposes only and is not intended to be investing advice.

Featured photo by m. on Unsplash