0
$\begingroup$

So im just a little cloudy on how shorting a stock drops the share price. I understand that you borrow, or set aside shares from your brokerage to then buy later at the origional price. My guess was that it just dropped because of the lack of shares available to buy since you are holding them instead of buying and selling, is this right? I cant find a solid answer anywhere, just not sure how to word it in a search bar.

$\endgroup$
1
  • 2
    $\begingroup$ In principle any sale of stock puts some downward pressure on the price (and any buying puts some upward pressure). For a small sale or buy it is negligible of course. It does not matter if you sell stock you own or if you sell stock you just borrowed 5 seconds ago from your broker, the result is the same, there is increased supply coming into the market that has to be absorbed, with a potentially negative effect on price. $\endgroup$ – noob2 Jun 4 at 21:52
1
$\begingroup$

Tldr: to execute a sell order immediately you have to cross the mid price to meet existing Bid prices below that price, moving the price downward.

On an exchange (where we would expect to see most equity trading), trades are executed by members of the exchange posting orders to the exchange (electronically), which then puts the order in its order book and disseminates current orders to other members.

If you are looking to sell (as in a short), then your Offer order is added to the Offer side of the book, amongst the other such orders. You can set the price where you'd like, including at a higher price than others, but the exchange will put the orders sorted by price, so a higher price will be a lower priority to actually trade.

The same thing happens for orders to buy, so the price information coming from the exchange is a list of the volume available at each incremental price; the best (highest) Bid and the best (lowest) Offer will be the best prices at which you could immediately execute a trade by fulfilling those orders, so generally people treat the midpoint between these best prices as the current price of the security.

If you want to execute your short immediately, you have to cross the mid, and sell at the highest Bid price - this does a few things; it executes a trade publically at that best Bid price which was below the mid, and it knocks out some of the orders sitting on the bid side. Both of these are downward price signals for a security. After the trade has matched, an immediately following sell order would execute (on average) at a lower price.

The more sell orders, the more this continues, with the Bid side if the book getting depleted.

Some of the orders near the top of the book (best Bids and Offers) are placed by market makers; entities who provide liquidity either by duty or to profit from general frothiness of prices, making a small profit by buying slightly below the mid and selling slightly above it. These orders tend to be for smaller volumes, with larger volumes available at slightly worse prices; so if you need to execute a larger short, you will have to hit not just the best Bid orders, but the next orders at lower bid prices as well until your order is filled. So a larger short will hit more orders and move the mid price further than a small one.

These days often larger orders will be executed on dark pools, which exist so that institutions can trade large blocks without moving the needle in advance; here the orders are not seen publically until after the trade has happened and been posted to the exchange, enabling them to get a better overall price on the order than if they had to trade through the exchange's order book.

$\endgroup$

Not the answer you're looking for? Browse other questions tagged or ask your own question.