【硬核加长版】真正的做空

Hello peeps, today’s video content is very hardcore

Let me tell you

when I was preparing for the content

I can feel that all the ideas and knowledge

were pouring out

Are you all ready?

Today we're going to talk about

Short Selling

Talking about short selling

we can feel that in financial market people are having fun doing it

For example in the movie The Big Short they were short selling subprime mortgages

Muddy Waters Capital shorted Luckin Coffee China Concept Stock

Soros shorted GBP

and last year Wall Street vs. retail investors and their various short selling act

Today Lin has prepared to combine all these

classis cases

of course there are some success stories as well as failed stories

Let’s go through the whole logical process behind it together

and understand what is short selling

how many ways to do it

and why it’s not as simple s you think

Now will be a good time to give a thumb up

It's not difficult to understand the concept of short selling

If you know what it means

you can skip this part (jump to 2:22)

Under usual circumstances

if we want to invest

and you have spotted a stock or futures

you'd expect it to rise

and you'll buy in right

You'll wait for it to rise and sell it

and make a profit from it

We know that these finance products they can rise and certainly it can fall

If I expect a stock to fall

can I make money from it?

Actually it’s easy

just change the order

I'll sell it first

when the stock drop, I'll buy it in

and earn money from it

This is short selling

Of course some people will be more specific in

differentiating between short and short selling

most of the time we’d use it interchangeably

so that’s how we will use it too

Some ask, to short sale we have to sell first and then buy

But what if I don't have the stock?

How do I sell?

That's a good question

Now you have to find a person

to borrow this stock

and then sell it

and buy it back when the price fall

return it back after you bought it

For example

if you think a stock is bearish

Lao Wang Tea Shop, definitely not Xiao Lin Tea Shop

Right now the price of stock of Lao Wang Tea Shop is 100

But you think it’s not going well

that the price will definitely fall

Now you want to short it

but you don’t have the stock of Lao Wang Tea Shop on hand

what to do now?

Look next door there’s a guy named Lee

He has the stock of Lao Wang Tea Shop

You can ask him, hey Lee can you borrow me your stock?

Lee borrow his stock to you

You sell the stock

Now you have 100

Two days later, as per your expectation

assuming the stock price fall to 50

and you buy it back

You actually just spent 50

The remaining 50 is your profit

Then you can return the stock you bought

to the owner, Lee

There’s no loss for Lee

as he is holding the stock of Lao Wang Tea Shop in long term

For you however,

you’ve earned 50 bucks

This is the basic procedure of short selling stocks

We borrow and then sell it

Buy it back and return it, there you go profit

The procedure seems simple enough

But if we dig a little dipper

there are two problems

Lets see if you have the same doubt

First, where do you think we can find a man like Lee?

How would you know who would be holding Lao Wang Tea Shop’s stocks

Second, even if you can find Lee

Why would Lee borrow his stocks?

Let’s talk about

the first question

Where to find Lee

Now is the time you find an intermediary

Generally, you can find securities company

because there are many ppl open an account with them

so they would know who is holding Lao Wang Tea Shop stocks

They can help you find the Lee(s) who are willing to borrow their stocks

But of course if you are big short seller investors

you can have an investment bank to serve you

There is a department in investment banking

called Prime Brokerage

They are responsible for helping you to find the Lee(s)

Alright, second questions

Why would the stockholders borrow you their stocks for no reason

Of course it’s not for no reason

We know in the financial market

you need to pay interest for borrowing money

Similarly, you have to pay interest when borrowing stocks

We’ll get into details later

So to simplify

in theory

Short sale is essentially the opposite of buy long

One hope the stock price will rise

Another hope the stock price will fall

that's it

Normally if people talk about shorting

they’ll stop here

Look at our time bar

it's only there

The interesting part

has just begun

Let’s look at short selling in our actual world

See how it’s being done

Didn’t we say earlier that shorting means you get more profit if the price of stocks fell more?

Assume that Lao Wang Tea Shop stock price is 100

It goes to bankruptcy when it fall to 0

and you’ll earn 100

On the other way around

if one day

Lao Wang Tea Shop

released a big piece of good news

For example he collaborate with Xiao Lin Tea Shop

The stock price will definitely increase sharply

to 200, 300, 400

now at this time you will lose 100, 200, 300

The more it rise the more you lose

and your hair will also starts falling

infinitely

This is one main characteristic of

which is that you will face limited profit

and

maybe it’s nothing in theoretical model

it’s just a characteristic of the distribution of payoff function

However in reality it will cause fund manager

to lose bunch of hair

What you face when you do short selling is infinite losses

So as a fund manager who short sells for long term

you will face anxiety

You'd often see a stock

rise several times in a year

we're not just talking about individual stock

Just US large-cap stocks alone from March 2020 until 2022

have doubled up

Evem large-cap stocks have doubled up

those short sellers are definitely not having the best time

We mentioned in previous video

about Enron financial fraud case

In fund circle

there is one particularly famous short-seller

In 2010

in his analysis he found that

there’s financial problem within Enron

so he began to short sell Enron

and earned $500 million

and rose to fame

Later he succeeded in shorting Luckin Coffee

and a German company, Wirecard

which also involved in financial fraud

There was also a car rental company in the US that went out of business

called Hertz

Isn't he great, aimed one caught one

But even the best man make mistakes sometimes

And we just said that shorting will face unlimited losses

For example in 2016

After a rigorous analysis by Jim Chanos

He has a new shorting target

Tesla

He did a fundamental analysis

and found that Tesla’s stock price is ridiculously high

In comparison with other car manufacturing companies

Like BMW, Mercedes Benz

it’s absolutely illogical

So he started to build a position to short Tesla

Often during interview

he would promote his theory

Actually in the first 3, 4 years it was still quite okay

Tesla’s stock was moving normally

because the public don’t know what Tesla

could build

During 2018, 2019

Tesla’s production grew exponentially

People’s doubt toward Elos Musk faded

When the market hasn’t reacted

Chanos had the chance to withdraw

but not only he didn’t withdraw

During an interview at the end of 2019

he still claimed that Tesla was overvalued

Well we know what happened

Imagine Chanos’ hair

just dropped a handful

From 2016 when he started to build position to short Tesla

until he pulled out, Tesla’s stock increased by 18 folds

Luckily he has a rule

Not one individual stock

can exceed 5% in his

investment portfolio

His principle actually saved him this time

so that he didn't end up badly out of pocket

But even so

The investors’ money are mostly pulled out

Actually not just Chanos

Tesla is the most shorted stock in history

It’s just that Chanos was

the one who made the loudest noise

These shorters were indeed unlucky

they went against Elon Musk

According to statistic, in 2020, those who shorted Tesla

had lost

$40 billion in total

Imagine how many tonne of hair fell of from these fund managers

Another example, before 2008 subprime mortgage crisis

actually there are many short sell institutions already saw bubbles

Like in the movie The Big Short

Fund manager Michael Burry

started to use various financial products

like Credit Default Swap (CDS) to do Valuation Adjustment Mechanism (VAM)

You see, as assets rise,

he loses

he was at the end of the rope

and prohibited investors to pull out their funds

He was working very hard every day

days were like years

he almost couldn’t make it

But fortunately

not fortunately

It’s fortunately for him, the subprime mortgage crisis erupted

He went through it and survived

but there are many fund managers

they didn’t make it

So you see shorting has a bottomless pit feature

It’s very terrifying for a fund manager

shorting is really not a job for anyone

If you’re not careful, you could end up like Chanos

A lifetime of fame is ruined

This simple method of shorting

has too much of risk

so in the market, hedge fund managers

that focuses on shorting stocks like Chanos

are actually quite rare

In fact, in most cases shorting is accompanied by hedging

which means when I’m shorting a stock

I’ll buy long on another stock

or buy long on large-cap stock index futures

This is a very common hedge fund strategy

and this is called Long-Short strategy

Example, I think Lao Wang Tea Shop stock will fall so I can short it

But I’m worried that the market will go bullish

at this time I can buy long on another more stable stock

like Xiao Lin Tea Shop

Under such circumstances

assuming in the market both stocks rise or fall together at the same time

My earnings will not be affected

In another word, buy short one stock and buy long for another

I have hedged the systemic risk of the market

Sometimes we also call it Beta

But as long as my long position in Lin Tea House

performs better than short position in Lao Wang Tea Shop,

I make money

Let me mention one more thing

Actually sometimes

This long-short strategy

doesn’t mean that if I’m shorting an individual stock

I have to buy long one individual stock

Sometimes I can short an individual stock

I can buy long on stock index futures

Can be directly understood as you buy long on large-cap

For example I short sell on Lao Wang Tea Shop

at the same time I buy long on S&P stock index futures

or I buy long on Xiao Lin Tea Shop

and short sell large-cap stock index futures

Usually it works like this

a bit complicated

but it’s actually very common in hedge fund

In long-short strategy

there is a classic player

a big shot in hedge fund world

His name is Julian Robertson

we'll call him Rob

We've mentioned him before in one of the previous video

He founded Tiger Management

From the 80s

he has been using just this one strategy

which is long-short strategy

In 15 years

he managed to use $8 million

and earned $7 billion

increase by almost 10,000 times

In the 90s Rob and his Tiger Management

was a God-like existence

From 1995

with the rapid development of Internet technology

there were a lot of Internet companies emerged in the market

that were not profitable

had been listed for financing

The U.S. stock market went into bullish mode

but Rob

a very steady investor

still look at the fundamental

He believed that these Internet companies were overvalued

so he started to short these Internet companies

and at the same time he bought long on Blue Chip Stocks to hedge

It’s what we talked about before

Long Short Strategy

Unexpectedly, those Internet companies were still in bullish momentum

The valuation models in the market at the time could no longer explain the value

So they came up with some new models

and used it on Internet companies

If I wanted to estimate the value of a customer

and look at growth index

and give a valuation on these Internet companies

The whole Internet industry was booming

At this juncture, not only was Rob

losing money due to bullish stock price

but at the same time he was facing doubt from investors

Investors thought that

Internet industry is the future

how could you short it

I have to pull out my fund now

At this time, even though Rob believed that he was right

But the market was in very Bullish mode

On one hand he had to pay margin

On another, investors are pulling their money out

The size of his fund

went from $21 billion

down to $700 million

In early 2000, Rob couldn’t hold on any longer

I don't understand this market anymore

and shut down Tiger Management

I don't want to play anymore

But half year after Tiger Management closed down

All the money in the market had been attracted to the stock market

The passing game could no longer be played

So the stock started to plummet

The Nasdaq index fell by 75% in a year

Many Internet companies began to go bust

That was when people realise

those previous booms

were just bubbles

This is the story

we often hear

The Dot Com Bubble

Rob was actually right

Too bad he not only has to get it right

He also has to get his timing right

A lot of people think that

Rob pulled out before

the bubble exploded

was a big mistake

But personally I admire him

He was looking at the bubbles getting bigger

and held on alone for so long

most importantly

imagine a legendary hedge fund manager

who under such huge losses

decided to quit

and pull out fast

it was actually a very difficult decision

So in the end he still managed to keep

His status as a hedge fund kingpin

After all, everyone knows

If you want to estimate market

estimate the right direction

It can still be within grasp

but if you want to get the right timing

not to say it’s impossible

it'll be harder than reaching the sky

These institutions they know

they can't just sit there and die.

You can’t pray all day

waiting for the stock to plummet

how long could you wait

Just like Chanos

When he was shorting a stock

he’d promote it around

Look at Tesla

it’s being overestimated

are you all blind?

But even with Chanos voicing out like that

The market was just ignoring him

Why do you think is that?

Because of Tesla's data

Everyone was actually there watching it

You may all quarrel

but you can only say how Tesla would be in the future

But when it comes to valuation

No one can convince the other about their valuation

The thing with this is each

can make their own justification

Chanos said that Tesla’s value was overestimated

Even Elon Mush twitted Tesla’s value was overestimated

But the stock price continues to grow

What can you do about it?

These shorters

has one move and that os

issue a research report

These institutions

will look for those

with actual financial fraud

or companies that actually commit fraud

and inform the market

there’s no need for valuation

it’s useless

because the data is false

it’s fabricated by the management

The management has character problem

In this case, regardless of whether the company's valuation is high or low

If you fabricate data

it’s a very serious taint

it’s an additional negative message

therefore the stock price will fall

Look how steady this is

When the price fall, I’ll be earning money from shorting

I’ll get to keep my hair

In actual financial market

there are vast amount of news coming out everyday

How to make the market believe what you claimed is correct

is real?

These institutions

will issue a

very detailed

research report

to prove that the company's finances are in trouble

It’s not just a simple 3 to 5 pages analysis

nor as easy as saying “I assume” or “I propose”

At least 20 or 30 pages or even tens of thousands of words are require

List the various crimes that this company is committing

Only then the market will look at you

Is there a company that comes to your mind?

A very famous company, that’s right

It’s Muddy Water Research

In fact, Muddy Water

its entire creation

including the idea of shorting

is all by chance

The founder of Muddy Water is

Carson Block

Carson isn’t majoring in finance

He has a PhD in Law

His startup failed when he was living in China

Carson’s brother is a stockbroker

In 2010

his father saw

a company named Orient Paper Inc

managed to be listed in US through backdoor listing

The company's financial report was very good

Annual revenue was about $100 million

His father thought he'd found such an amazing treasure

and he wanted to buy in a big amount of stocks

His son happened to be in China

This company is a paper mill

the operating model is easy to understand

So he would like his 33 years old son

who is Carson

to take a look at the condition of the paper mill

and also to train his son

Carson is an interesting guy

probably he read a lot of Sherlock Holmes as a kid

It was supposed to be undercover

but he went out of his way to find an American journalist

to contact Orient Paper Inc

and he himself posed as Chinese translator for the journalist

And these two

went in as a foreign media who wanted

cover the story of Orient Paper Inc

The management took them on a tour

They visited the factory

the production line

recorded a lot of visual data

Once he took a look at it

Carson found that Orient Paper Inc was actually in tatter

It wasn’t as great as reported in financial report

The plant and equipment are from the 1990s

These are photos taken when they were at Orient Paper Inc

and this is the photo of their competitor

Look at the comparison

He discovered that

$2.3 million worth of recycled cardboard allegedly reported by Orient Paper Inc

was actually a pile of paper shells lying out in the open, all soaked

According to their financial calculations

Supposedly

a company of the size of Orient Paper Inc

should have hundreds of trucks coming in and out every day

But what Carson saw was that

in front of the factory, there was only

single lane dirt road

They waited there for half an hour

and saw only one car parked out front

Carson was sure that

even that car

could be placed there by Orient Paper Inc

to put on an act

Carson knew they shouldn’t invest in the company

Dad, stop now

Not only we can’t invest in the company

we have to short it

And they really did short Orient Paper Inc

In June 2010

They published a 30 pages report

and exposed everything

It says in this report that it's estimated that in 2008

Orient Paper Inc’s turnover was overstated by 27 times

In 2009 sales were overstated by 40 times

Of course, Muddy Water openly stated that they shorted Orient Paper Inc

In the beginning it dropped a little

only 10%

after all Orient Paper Inc

was not some big company that can make waves

Muddy Water was also not well known then

The public had doubt about the report

But then as the media spread the news

this issue started to escalate

In the following days, Orient Paper Inc dropped 50%

Facing all kinds of doubts and problems

Muddy Waters published 8 reports within a month

to prove that their views are correct.

In the following years, Orient Paper Inc’s stock continued to fall

With this

Carson Block and Muddy Water

became famous

in this circle

Later they keep using this method

In November 2010, they exposed

and shorted RINO International

RINO admitted to committing fraud

and delisted

In February 2011

They exposed China Media Express

and later, China Media Express also delisted

In April 2011, they shorted Duoyuan Global Water Inc

it delisted as well

Including recently Luckin Coffee

Anyway, their reports are written more professionally and in more detail

They basically has only one trick

They first start with undercover visit

and then financial investigation

after they found target for shorting

they start to short, publish report

When the stock price fall, they pull out, make money and leave

Similar short selling companies

and the one we mentioned when talking about Nikola

Hindenburg Research

They also use the same strategy

Have you discover that these short selling companies that depend on research and publish report

instead of calling them a financial firm

you can call them investigation firm

They specifically look for dubious companies in the market

This approach also sounds very reasonable

it’s very clever

also useful to the society

It's about clearing out the bad apples

crack down on money hoarding in the financial circle

So in fact, for those companies

that keep their feet on the ground

it is a good thing

The problem is that these companies are not Justice Bao

thinking about eliminating harm from people

As a short selling institution

they must also want to profit from it

Although it is ideal to find such a blatantly deceitful company

but it's not really that easy to find.

Carson himself said that

the companies he is looking for must have these 3 major characteristics

First, it has to be large

the volume has to be large enough in order to make money

The company took so long to do all kinds of research

and the shorting

and once published, even if the stock fall, they would only earn 30k to 50k

It’s not worth the time

Why need to have good liquidity

Because if the liquidity is good, I can borrow the stock

and sell it, right?

We mentioned earlier there is a cost to borrowing stock

This cost depends on market supply and demand

If there’s always people who want to hold this stock

Like Apple Inc

The cost to borrow it for shorting will be very low

The annualized interest rate is about 0.25%

Demand for short positions like Tesla is high

therefore the cost for borrowing will be higher

about 2.5%

Another example, in early 2021

Wall Street vs Retail Investors, GME was heavily shorted

The demand for shorting was very high

At that time, the interest rate for borrowing GME reached nearly 80%.

sometimes it exceeded 100%

Which means for this stock

if you borrow it for one year for shorting

even if the stock fell to 0

you won't be earning money

This is why Carson said

The second L has to be those with high liquidity

The third one is Lying, that fraud exists

Think about it, a company that commits fraud

is certainly not easy to find

which means

you have to be the first person in the world

to discover that there’s a problem with this company

Moreover there are more and more short selling institutions

or research institutions looking for such companies

making it more difficult to find

This point is in conflict with the previous two points.

because a large company with high liquidity

the possibility of it committing fraud is very low

This is why institutions like Muddy Water

that depends on research

digging on info to short sell

they have very limited targets

the volume will be limited as well

For example, according to a report Muddy Water made to the SEC

They are actually only managing $260 million

with only 8 employees

What’s $260 million

in Wall Street? They are like little boy there

But actually amongst the short selling companies

they are very famous

The management scale of Muddy Water is not very large

for them to find a smaller volume company to short

is actually not that difficult

But the truth is otherwise

So you can often see Muddy Water

when they publish a report, they will say

We have reason to doubt

or we seriously doubt

or we have reason to believe

Because they don’t really have concrete proof

At the time when he shorted New Oriental

and shorted ANTA, it was actually base on guesses

So you see these short sellers shout louder than anyone else

That's also for business needs

You have to look at

their volume in capital market

and it’s actually very little

Previously we talked about Chanos

his asset was around $1 billion

At its peak, he was managing $6 billion

This is already very well known among short sellers

How much do think Warren Buffett's asset is

It’s close to $300 billion

In entire US stock market

there are only 3%-5% of stocks

being shorted

Most of it are

like the ones we mentioned in the beginning

Tiger Management

which uses long-short strategy

Those like Muddy Water who caught one short it

is actually very rare

This is why when someone asked Buffett

what do you think about shorting

Buffett said

for our company, shorting is

just like a fly’s leg

So it seems that by simply doing short is not gonna take you far

Those big sharks don't bother to do these things to be detectives to investigate

But there is a shorting method that belong to these sharks

and that is speculative attack

When these big sharks

sense that in the market

there is an asset which its value

has been overestimated

and he sense that there are many people feel the same way

but for some reason

the asset price stays in high position

they can straight away use high volume of capital

to burst the illusion

They’ll tell everyome

come let’s sell it with me

so they will use large volume of capital

to give a downward push to the asset

When the market finds out that someone is taking the lead

Asset began to plummet

They will reflect on themselves

Was the price too high?

Was the previous valuation too outrageous?

I want to follow and sell it fast

Let’s follow the shark and get some meat to eat

If we can get enough strong feedback in the market

Then it will forcefully bring the asset back

to a reasonable price range

In other words, it is a good correction mechanism

However, these are all theoretical knowledge of shorting capital

and how it is good for the market

But after all, everyone is irrational

In fact

you can't correct it back to

a really reasonable range

because everyone will get panic

so sometimes there will be stampede accident

which exacerbate market volatility and

could even trigger a financial crisis

This is why short position receives much backlash

Lin often says the nature of finance is credit

It's the market's confidence in you

Let’s say if you give a company full confidence

full credit

even though it might have little problem but you can support it and it will get healthy

Conversely, if you forcibly suppress confidence

the company which is not very stable in the beginning

and you went up there and trample it

it would make the company unable to recover from setback

If there is some capital shorting you aggressively

That’s like pointing at your nose and saying you are bad

Market confidence towards this company will be a devastating blow

This situation is very detrimental to the stability of the market.

Many countries that are having a financial crisis,

or when a financial crisis

has occurred

they prohibit the act of shorting

They are worried that these attacks

will bring additional

unnecessary shock and volatility

Talking about speculative attack I have two persons in mind

Let’s see you and I are thinking about the same persons

Let’s see you and I are thinking about the same persons

First is Jesse Livermore

Second is, I think everyone will thought of him

George Soros

Livermore was a legendary big shorter

We have one episode that talks specifically about him

You can watch it after this video

perhaps there could be something new to learn

In 1929

through over 100 brokers

he started to short US Stocks in large volume

the market cannot withstand

this kind of speculative attack

stock price started to plummet

Indirectly, this led to stock market crash

and the greatest Depression in American history at the time

Livermore, of course, made over $100 million from this

profiting out of national disaster

So this issue was actually criticized by a lot of people.

Soros is a financial tycoon, right?

He was famous for shorting the GBP in 1992

But today we are talking more about shorting stocks

Shorting foreign exchange and shorting stocks are two different concepts

Because when shorting foreign exchange

you are shorting a currency

it’s equal to buy long on

another currency

For example if you are shorting USD/JPY

When you short sell USD, at the same time you are buying long JPY

It is always a two-way symmetrical relationship

It's different from shorting stocks directly

Although we said Soros was shorting GBP

but it doesn't really have that much to do

with buying long and selling short

It’s just a pure speculative attack

still quite interesting nonetheless

If you are interested in this let me know in the comment

I’ll consider it and perhaps have an episode about this

Actually, we've talked a lot for today

But in the beginning I said

The ideas just kept flowing out

So we try to dig a little deeper

If there’s speculative attack

then there will be

speculative counterattack

Shorting is when someone bets against a stock

While shorting

it will usually be accompanied by a very strong speculative counterattack.

Because there are always people who don't want this stock to fall

Who are these people?

Like shareholders

shareholders

they certainly wish the stock price to increase

The management certainly wish the stock price to increase

who else? Brokers, market maker

Theoretically it doesn't matter to them whether the stock goes up or down

But they want the market to be active, they make more money when the market is more active

When are they usually active? It must be when the stock is bullish

When everyone is happy, It’s very active to sell at this time

So the brokers and market maker wish the stock price to increase

Who else? like media, investment banking, research institutions

these institutions

in theory, they should be neutral, right?

Their job is just to publish research report

But the problem is that these institutions are easy to be bribed

So in general they will more or less report more good news than bad

The short sellers are the only ones in the market

who stand firmly against everyone and

hope that price of stocks fall

Imagine how much pressure their little crowd is going to face

Since a lot of people want the stock price to rise

they will use various way to give positive incentive to stock price

Buffett once said

If you want to short a stock

without concrete proof

Then people you stood against will beat you up

So for shorters

you either have to have enough volume,

or you have to have enough ammunition

to hold out against

a field of people

Let me tell you a story

Two years ago the capital market was bubbling with noise

about the game between short selling and speculative counterattack

there is a hedge fund manager, Bill Ackman

Let's just call him Ackman

He’s incredible

In 2015

the management scale

had reached $16 billion

In 2013

He found a company

Herbalife Nutrition, a company that sells supplement

He noticed that this company never advertises

not many people heard of it

but its annual sales are $4.8 billion

What's going on here?

Upon investigation

he found that

Herbalife uses one marketing approach

Anyone

can become an independent seller of this brand

You can buy their products at discounted price

and then you can sell their products

You’ll get commission when you sell

Sounds normal

but there’s one unusual part

This marketing model

has a professional term

Multi Level Marketing (MLM)

Does it sound like a pyramid scheme to you?

Pyramid scheme also recruits members layer by layer

Actually the line between MLM and pyramid scheme

is often blurry

What matters is whether the products

are actually being sold to consumers

If it’s sold to consumers

you can call it MLM

But if you are earning money

from the people you recruits

it’s a pyramid scheme

After Ackman made the investigation

He is certan that Herbalife

is a pyramid scheme

and he started to short the company

He started by shorting $1 billion

Just one single position

is equal to

4 to 5 times Muddy Water’s volume

In the market,

Ackman is very influential

so when he said he is buying short

Herbalife’s stock price fell by 40%

Then just like we said

Ackman began to do things that’s related to shorting

He started to advertise and spent 30 to 40 million dollars

and publish report via various media

he even prepared a 300 pages PPT

to analyse Herbalife

how they started the scheme

According to Ackman's plan

some big shark leading the market with all his evidence in PPT

will definitely attract people to condemn Herbalife

then the stock price will dro[

SEC will intervene for investigation

the company will go bankrupt

and he will earn boatloads of money

Right at this juncture came a saboteur

Another shark called Carl Icahn

Carl Icahn

Icahn has been known for hostile takeovers

He is especially good at

acquiring companies that seem to be not performing

and restructure them

Icahn was watching Ackman shorting Herbalife

with $1 billion position

and he began to go against Bill

and bought in the stocks

The stock price increased by 20% on that day alone

He also started to promote and

told the public that Ackman was a liar

that he is shorting the stock just to earn money

that's why he started this

So now you’re just looking at two billionaires

starting a war of words

The onlookers were just enjoying the show

From the market performance

you’d know that the public is keen to believe

in the view that capitalists are evil

and the public sided with Icahn

The stock price rose slightly amid continued volatility

In 2014

there is an agency in US called FTC

Federal Trade Commission

So FTC started to investigate Herbalife

Two years of investigation finally bear fruit

FTC fined Herbalife with $200 million

ordered them to rectify its marketing model

and a bunch of financial penalties

see there’s another penalty

and rectification order

Sounds like Ackman won right?

too bad it’s not true

The sharks are truly amazing

When the news broke out

both of them were still arguing

Ackman said see there’s penalty

obviously the company has problem, I won, it’s a pyramid scheme

Icahn said it’s just a small fine

FTC didn’t say it’s a pyramid scheme

You are not right

In stock market, sometimes you really cant tell why

After the stock fluctuate briefly

all of a sudden it started to go up

2017, it increased by 51%

With such increase

The short position made by Ackman was like a bottomless pit

We mentioned earlier that shorting could incur infinite losses

Under such situation

Ackman had to

empty his position

and started to buy put options

Unexpectedly the stock continued to rise

in the end he gave up on options

and left quietly

With Icahn’s blocking

Ackman lost $1 billion

How miserable

We are getting deeper into the topic

But in the story

I purposely left out

one very important core logic

Why do you think Icahn rushed in

to bet against Bill knowing

Bill had spent $1 billion on short position

Does he has nothing to do?

betting against another shark

What if you lost?

RIght

But of course Icahn didn’t tell me

what he was thinking

I can only analyse based on my past experience

I think if Ackman didn’t short the stock

Icahn probably wouldn’t acquire Herbalife

He just wanted to bet against Ackman

There’s a very important reason behind this

It’s called short squeeze

We mentioned that when you short a stock

you actually have to borrow stock from broker or securities company

Securities company has to guarantee that

you have to give the stock back

after you’ve borrowed it

they will ask you to pay

something call Margin

Icahn knew someone is shorting $1 billion position

What will happen if he buy long in large volume?

Stock price will rise

In short term Ackman will lose money

When he loses money

broker will asked him to pay margin

If the stock continues to rise

Ackman will have to keep paying the margin

Until one day he couldn’t pay it

he’d have to liquidate

What would he do after liquidation

He will buy back Herbalife stock

with large volume of long position

It’ll cause Herbalife’s stock price to soar

This kind of soaring stock price due to forced liquidation

is actually a short squeeze

At the time Icahn bought in long position

he could earn a lot from it

We know Ackman is rich right

his foundation is quite solid

in Icahn’s mind

even if he can’t kill in one shot

he can just drag this

because as we mentioned

you need to borrow stock for shorting

it comes with a cost

The position as big as $1 billion

actually incurred very high cost

the longer he waits the more he loses

Ackman might not be able to hold if it dragged on

Icahn bought long on Herbalife

at most, if the stock dropped to 0

he’d only lose $1 billion

But if short squeeze appears

He could earn more than 100%

This was Icahn’s wishful thinking

Why do I think that, you ask

Actually at the time, Icahn was

already Herbalife's largest shareholder

and board director

Once Ackman announced he is pulling out

Icahn followed suit and quit the board

and even liquidate his position

Obviously he was not interested in Herbalife

He just wanted to use short squeeze to force Ackman into a corner

and profit from it

What do you think?

Does the logic makes any sense?

Let me show you how wild a real squeeze can be

Let’s move back in time to 1901

There was a railway company in US

the name is not important

there were two people, you don’t have to know who, not important

These two guy were vying for control of the company

In March and April 1901

they bought in a large volume of the company’s stock

The stock price rose from $20

to $130

There was a bunch of traders who didnt know what's going on

The stock price looked inflated

I have to short it

but the two guys were fighting hard

and they kept buying the stock

stock price went up to 150, 180, 200

when the shorter saw this

they wanted to quickly liquidate and leave

If they liquidate they have to buy back the stock

But then the two guys who were vying for control

none of them wanted to sell their stock

They've bought all the stocks available in the market

It’s impossible to buy back

The shorters were in panic

they were rushing in to buy

which increased the price further

Look at the stock price

from 200, 300, 500, 800

until in the end it rose to 1000

But no matter how high the stock price

they cant buy in

This is the ultimate squeeze

For these shorters

They were facing enormous loss on the book

The brokers were asking them to pay margin

they cant pay anymore

so the broker had to sell their other stocks

to pay for margin.

When they started to sell

it triggered

a stampede across the whole market

This is the Panic of 1901

Fortunately, the two men also realize the graveness of the situation

and decided to stop

cut the shorters some slack

and sold the stock to them for $165

The market finally stabilise

Even if the price was not as high as $1000

$165 is enough to make these shorters lose money

Two people fighting for control

at the same time made those small traders lose money

Isn’t that kind of amazing

Squeeze cases like this

happen very often in the market

Manipulating market

may sound exciting

but it has negative impact

on market stability

because there is no longer rational consideration

on the level of valuation

it’s based on sheer compulsion and panic

Just like the Tiger Management we mentioned

during the Dot Com bubble

they didn’t manage to hold on

and had to leave

If you look at Nasdaq Index at the time

you’d notice a surge before the bubble burst

Many suspected that

because of

big shorter like Rob was short squeezed

the surge happened

we usually see many interesting cases of these big shorts

it’s as if they've earned a lot of money

But in the cases I talked about today

a lot of them are about shorters being beaten up

Not that I purposely choose these cases

it’s actually very difficult to buy short in the market

like how we analyse just now

they have to face limited profit

infinite loss

target is limited

high cost of borrowing

pressure from the management to bet against

and the risk of being short squeezed

and of course massive hair loss

One more point, when we talk about shorting

a lot of people think it’s evil

and hated it

because if you buy long

even if there’s capital manipulation

everyone will profit when the stock rise

The whole market will be happy

If the stock dropped, everyone loses money

it’s bearable mentally

If you earn money by shorting

That must be because the stock price dropped

A bunch of people in the market wouldn’t be happy

so it feels like

they were taking pleasure in other’s pain

Another cost that has to be bore by shorters

is moral pressure

before this, people might just swear at you a little

or scoff at you

But it’s different after 2021

In the beginning of the year

the market bubbling with noise about

Wall Street vs Retail Investors long short war

this is purely because of the retail investors’ disdain on Wall Street shorters

So they started to buy in

stocks like AMC, GME

I don’t care about your valuation

I don’t care if I lose

I just wanted to bet against you

This forced a lot of the shorters

like Melvin Capital

to lose 50% in January 2021

Just GME stock alone

cost the shorters $91 billion

This case is textbook material

So you see when these shorters are too rampant

the whole market will revolt

I’m so tired

Is your brain now full of

knowledge

There many ways to short a company

you can also short options

stock index futures

you can do equity swap

stock swap

or something even more dramatic

like CDS credit default swaps etc.

But a lot of this is more mathematical

and the average person can't buy it

So today we only touch on shorting stock

Shorting stock sounded exciting

but there are too many traps and potential risks

that most people wouldn’t dare to touch it

Even some professional investors wouldn’t dare to short

This is why we often hear mutual fund, insurance

pension scheme they are not allowed to short

Because these are people’s life-saving money

No one can bear to let the fund manager to gamble it away

Of course we talked about

many features of shorting

that give so many interesting stories

Theoretically shorting could help market to increase liquidity

help the asset to correct and fall back to reasonable price

However, in the many true stories that had been told today

did you notice that it’s not that simple

in financial market

Lin had enough fun talking today

I think you are enjoying it too

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